The Federal Reserve has executed one of the quietest yet most consequential policy shifts in recent years. On December 1, 2025, it officially ended quantitative tightening. Eleven days later, on December 10, it delivered another 25 basis point rate cut, bringing the federal funds rate to a target range of 3.50 to 3.75 percent. Taken together, these moves mark a deliberate transition from broad monetary restriction to selective easing. The balance sheet will no longer shrink, but the composition of that balance sheet is changing in ways that matter enormously for mortgage-backed securities and, by extension, for housing, fixed income investors, and the broader economy.
Understanding the New Rules of the Game
For the past three years, the Federal Reserve has been running quantitative tightening. Every month, maturing Treasuries and agency mortgage-backed securities were allowed to roll off the balance sheet up to predetermined caps, effectively destroying base money and withdrawing liquidity from the financial system. That phase ended on December 1.
The new regime is simple in appearance but sophisticated in effect. When Treasury securities mature, the Fed now reinvests every dollar of principal back into new Treasury securities, primarily short-dated Treasury bills. When mortgage-backed securities pay down principal (through scheduled payments or homeowner refinancings and sales), the Fed still refuses to buy new MBS. Instead, every dollar received from mortgages is redirected into Treasury bills. The overall size of the balance sheet stays roughly flat at seven point two trillion dollars, yet the Fed is quietly selling exposure to the mortgage market and buying exposure to government funding needs.
Why Mortgage-Backed Securities Are the Only Asset Still Under Pressure
At the end of November 2025, the Federal Reserve owned approximately two point zero five trillion dollars of agency mortgage-backed securities. That portfolio continues to shrink by fifteen to twenty billion dollars each month. Private investors, primarily banks, money managers, and foreign central banks, must absorb that supply because the largest historical buyer has stepped away.
The result is predictable. Mortgage-backed securities now trade at wider spreads to Treasuries than at any point since the global financial crisis. As of December 11, the option-adjusted spread on current-production agency MBS sits between one point eight and two percent, well above the long-term average of roughly one point five percent. Thirty-year fixed mortgage rates, which closely track the yield on the current-coupon MBS, have settled in the low-to-mid six percent range despite three Federal Reserve rate cuts in 2025.
The December Rate Cut in Context
The Federal Open Market Committee’s decision to cut rates again on December 10 was widely anticipated, yet the details revealed a divided committee. The vote was nine to three, with two governors preferring no change and one advocating a larger fifty basis point cut. The updated dot plot now shows only one additional cut penciled in for all of 2026, a notably hawkish tilt compared with market expectations of two or three reductions.
Markets initially rallied on the news, interpreting Chair Powell’s press conference as dovish in tone. By the following morning, however, the ten-year Treasury yield had climbed back above four point one seven percent, and mortgage rates ticked slightly higher. The message is clear: short-term rates are coming down, but the Federal Reserve has no intention of restarting outright balance-sheet expansion or resuming purchases of mortgage-backed securities anytime soon.
Consequences for Financial Markets
Fixed-income markets are experiencing a classic steepening of the yield curve. Short-term Treasury yields have fallen in sympathy with the federal funds rate, while longer-dated yields remain anchored by persistent inflation concerns and the prospect of larger fiscal deficits. Mortgage-backed securities sit in the uncomfortable middle: they benefit from the general decline in funding costs, yet they remain the only major asset class still subject to forced selling by the central bank.
Equity markets have taken the developments in stride. Bank stocks have rallied on lower funding costs and the prospect of regulatory relief that would allow greater Treasury holdings. Real estate investment trusts with heavy residential exposure have lagged, reflecting the reality that six-point-three percent mortgage rates continue to freeze existing homeowners in place and dampen transaction volumes.
What Investors Should Do with Mortgage-Backed Securities Now
Income-oriented investors find agency MBS unusually attractive. Current yields of five point five to six percent, combined with a spread pickup of nearly two hundred basis points over comparable Treasuries, offer compelling carry in a world of falling short-term rates. Exchange-traded funds such as the Vanguard Mortgage-Backed Securities ETF (VMBS) and the iShares MBS ETF (MBB) provide liquid, low-cost exposure.
Total-return investors face a more nuanced decision. The same runoff that creates attractive yields also introduces negative convexity and extension risk. If rates fall further and refinancings accelerate, the duration of existing MBS pools lengthens, exposing holders to greater price declines should long-term yields rise. Hedging with Treasury futures or maintaining a barbell of short-duration Treasuries and current-coupon MBS remains prudent.
Opportunistic buyers are watching for spreads to widen toward two point two percent or beyond. At that level, MBS would price in a degree of pessimism that has historically preceded strong subsequent returns.
Looking Ahead
The Federal Reserve has engineered a policy that eases financial conditions without reigniting the political criticism that accompanied the explosive balance-sheet growth of 2020 and 2021. By maintaining runoff on mortgage-backed securities while supporting Treasury issuance, it has prioritized the federal government’s borrowing needs over the housing market’s desire for lower rates.
Whether this balance can be sustained depends on incoming data. Should the labor market deteriorate more sharply or housing activity collapse, pressure will mount to slow or reverse the MBS runoff. For now, the Federal Reserve appears willing to tolerate modestly higher mortgage rates in exchange for greater control over long-term yields and inflation expectations.
Investors who understand that mortgage-backed securities remain the only major asset class still experiencing quantitative tightening are best positioned to navigate the months ahead. In an environment of stealth easing everywhere else, MBS represent both a source of generous yield and a barometer of how far the Federal Reserve is willing to let the housing market strain before changing course again.
