FILE PHOTO: An eagle tops the U.S. Federal Reserve building's facade in Washington, July 31, 2013. REUTERS/Jonathan Ernst/File Photo

By Matt Tracy

(Reuters) -U.S. bond firm PIMCO said on Tuesday the Federal Reserve should consider a halt to the shrinking of its mortgage holdings in order to boost the U.S. housing market.

Since 2022 when it began its rate-hiking campaign, the Fed has shed the mortgage bond holdings on its balance sheet through quantitative tightening, where the central bank allows the principal and interest payments on mortgage-backed securities to roll off without reinvesting those proceeds.

Mortgage spreads, or the gap between Treasury yields and mortgage rates, have remained "unusually wide" as the Fed has maintained its mortgage shedding over the past three years, according to PIMCO's Tuesday report. Those spreads stood "near historically wide levels" at roughly 230 basis points as of Friday, according to PIMCO.

This in turn has contributed to a high 6.35% average rate on the 30-year mortgage, which is the most common house loan taken out by Americans.

Reinvesting the proceeds of principal and interest payments by mortgage borrowers behind MBS on its balance sheet could do as much, if not more, than rate cuts to lower mortgage rates, wrote Marc Seidner, chief investment officer of non-traditional strategies, and Pramol Dhawan, portfolio manager at PIMCO.

"In a cycle where interest rate policy is politically fraught and inflation remains sticky, the Fed may find that the most effective easing tool is already hiding in plain sight," they wrote.

One option suggested by Seidner and Dhawan would be to reinvest the current MBS roll-off, which averages roughly $18 billion each month. They estimate that could reduce mortgage rates by 20 to 30 basis points.

"It could deliver as much bang for the buck as a 100-bp cut to the federal funds rate, which is what has historically been needed to achieve a similar drop in mortgage rates," they wrote.

Another option would be to both reinvest the current MBS roll-off and sell between $20 billion to $30 billion in their MBS to reinvest in current securities. This could lead to a 40 to 50 bps reduction in mortgage rates, Seidner and Dhawan wrote.

Either of these could prove a more effective option to lower mortgage rates than the widely-anticipated rate cuts at the Fed's coming meetings, they noted.

"If the Fed continues its current approach, expect mortgage rates to remain elevated through 2026, making homeownership a luxury good reserved for the wealthy," they said.

(Reporting by Matt Tracy; Editing by Chris Reese)