Hagen also believes the Fed may continue to allow mortgages to be dropped off its balance sheet if these conditions persist. There is also a question about how long the Fed will go before opting to cut rates again, after deciding to leave rates alone last week.
“Another outcome is that the Fed is less likely to do anything to its retained portfolio,” he said. “They’re currently letting around $20 billion of mortgages run off their portfolio each month. The expectation in the market is that they kind of end quantitative tightening (QT) sooner, and if there’s less demand from the foreign buyers, they could end QT sooner.”
‘Abnormal’ conditions in the market
The combination of high spreads in the MBS market, along with a slight decrease in rate volatility, is not a typical occurrence, according to Hagen.
“It is abnormal to see spreads stay this wide, with interest rate volatility coming down or moderating a bit,” he said. “A lot of that we can attribute to foreign demand. It’s not just an MBS thing, it’s treasuries too. The foreign support for treasuries is the bedrock of that whole picture. The tariffs are having a very meaningful kind of secondary effect on interest rates.”
Even though Hagen believes that rates could go higher, he also notes a lot of the uncertainty makes that hard to predict. He said that under normal circumstances, some of the things happening in the markets would normally drive rates down.