Recent changes to the yield curve (higher, a bit steeper again) have resulted in much higher levels of financial market volatility and have raised mortgage rates to levels not seen since 2011. While the impact on mortgage and credit spreads has so far been muted, the potential impact on home-price growth going forward, as well as on new home starts and housing turnover, has been much discussed. Against this backdrop, we present two articles that dive a bit more deeply into the topic of home prices and of rates and spreads.

In our first article, Alex Levin discusses and explains modeling choices that reflect commonly ignored features of home-price dynamics. In particular, he points out that in our modeling framework, we do not posit mean reversion of home prices to their economic equilibrium. Additionally, he shows that the dynamics of the CCAR severe stress scenario lays outside our model framework and if that scenario is used for forward CECL assessments, banks would need reserves that are multiples of scenario-projected lifetime losses. Finally, Alex’s discussion of how affordability shocks (such as those that come about due to higher costs of equity or higher mortgage rates) impact modeled prices over time should be of particular interest given the rise in mortgage rates.

In our second article, I take a look at Quantitative Tightening (QT) a year in. While it started slowly, the process of unwinding MBS and Treasury positions from the Fed’s balance sheet has reached the full run rate per their original plan. This has the potential to decrease the money supply by up to $50 billion per month—though we show that MBS are likely to decline well below the capped rates. This will result in the MBS portion of the portfolio potentially becoming larger than the Treasury portion, without changes to the current plan for QT. The article also looks at what has happened to the yield curve and spreads since QT began.

Since the onset of the last credit crisis, investor interest in home prices, as a driver of borrower behavior and the mortgage markets, has increased sharply. AD&Co’s home-price modeling efforts—which began in 2005 and have reached their third generation (“HPI3”)—is a reflection of that interest.

This article discusses and explains our modeling choices that reflect frequently ignored features of home-price dynamics. We filter and treat HPI surprises statistically, assuming they bear information about longer-term trends. We do not posit mean reversion of home prices to their economic equilibrium. We find the dynamics of CCAR severe stress scenario to lay outside modeling realities and demonstrate that, should that scenario be used for forward CECL assessments, banks would need reserves in multiples of scenario-projected lifetime losses.

October 2018 marks one year since the Federal Reserve’s Quantitative Tightening (QT) program began. Subject to a quarterly rising set of caps, maturing Treasuries and MBS (mortgage-backed securities) from the Fed’s portfolio began to not be fully reinvested into those asset classes. This gradually drains the excess money injected into the economy during Quantitative Easing (QE) as part of the Fed’s “extraordinary measures” taken in response to the financial crisis. In this article, we look at what has happened to Treasury and MBS balances on the Fed balance sheet over the past five years and what may happen in the next several years. We also examine the impact on the yield curve and fixed income spreads across several asset classes.