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Aug. 3, 2021, 11:36 a.m. EDT

Home prices could cool when the Fed tapers its bond-buying program. But a crisis? Unlikely.

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By Joy Wiltermuth

U.S. home prices have been rising at a record annual pace in recent months, fueled in part by historically cheap credit , the absence of properties for sale, and the scramble by households for more space as families have fled to the suburbs during the pandemic.

Can the good times last when the Federal Reserve finally cuts back on buying mortgage and Treasury bonds? Here’s how mortgage rates and a less gargantuan central bank footprint could impact the heated U.S. housing market.

“The Fed is certainly talking and thinking about it,” said Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research, on the subject of how the Federal Reserve could scale back the central bank’s $120 billion a month bond-buying program.

But Jones also thinks tighter credit conditions, likely via higher borrowing rates as the Fed tapers its bond buying program, might end up being a saving grace for today’s housing market.

“Housing prices could certainly pull back, after accelerating so fast,” she said, pointing to households fighting over the few properties available to buy, while navigating work from home. “At some point,” she said, mortgage payments on high-priced homes “become unsustainable with people’s incomes.”

“But I don’t see a big housing debacle.”

How to pump the brakes on housing

The central bank has maintained a large footprint in the mortgage market for more than a decade, but the worsening affordability crisis in the U.S. housing market led Fed officials to walk a tightrope recently when trying to explain its ongoing large-scale asset purchases during the pandemic recovery.

Fed officials in recent weeks have expressed a fair bit of disagreement around the timing and pace of any scaling back of its large-scale asset purchases.

St. Louis Fed President James Bullard said Friday the central bank should start to slow down its bond purchases this fall and finish by March , saying he thought financial markets “are very well prepared” for the reduction in purchases.

During a midweek press briefing, Chairman Jerome Powell said tapering likely would start with agency mortgage-backed securities (MBS) and Treasury bonds at the same time, but also “the idea of reducing” mortgage exposure “at a somewhat faster pace does have some traction with some people”.

The blue line in the chart below traces the central bank’s balance sheet and abrupt path to a $8.2 trillion balance sheet since 2020 when its efforts to support markets during the pandemic began, with the red line representing its Treasury /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y -1.01% holdings and green line its MBS. /zigman2/quotes/207528740/composite MBB +0.02%

As of July 29, the Fed was holding about 31% of the roughly $7.8 trillion agency MBS market, or housing bonds with government backing.

“You could make the case that the Fed owns almost one-third of the agency mortgage bond market, and that it might make sense to loosen its grip,” Jones said, particularly as Powell has played down a direct link between its MBS purchases and climbing home prices.

It may now seem like a distant memory, but before the pandemic upheaval, that was precisely what the Fed was trying to do.

“Who would have thought,” said Paul Jablansky, head of fixed income at Guardian Life Insurance, that the U.S. would be in the midst of “one of the frothiest housing markets in history,” following last year’s extreme pandemic shutdowns that closed businesses, workplaces and national borders.

“Occasionally people ask, are we at the peak?” said Jablansky, a 30-year veteran of the mortgage, and asset-backed and broader bond market. “We are outside the balance of our experience, so it’s very difficult to say we are at the peak,” he told MarketWatch.

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