It’s clear that the free fall in U.S. home sales—which went into a sharp contraction after the Federal Reserve’s inflation fight saw mortgage rates spike from 3% to over 7% in 2022—is behind us.

On Wednesday, we learned that the seasonally adjusted Mortgage Purchase Application Index ticked up 3.1% last week to 190. On one hand, the index remains far below the 282 reading it had during the same week in 2022. On the other hand, the index has clearly stabilized in recent weeks after bottoming at a 159 reading during the first week of January.

While realtors and builders alike are cheering this news, improved housing data is getting a lukewarm reception from the Fed.

“The Wall Street Journal yesterday had a report that the [U.S.] housing market is starting to show signs of life again because mortgage rates have come back down,” Minneapolis Fed President Neel Kashkari said Tuesday on CNBC. He went on to say that loosening financial conditions (including mortgage rates which fell to 6.09% last week) isn’t great news for the Fed. “You’re right it [loosening financial conditions] does make our jobs harder to bring the economy into balance. All things being equal, that means we’d have to do more with our other tools.”

Why could loosening financial conditions and falling mortgage rates spell trouble for the Fed?

In the second half of 2022, spiked interest rates helped push U.S. home prices down 2.5% from their 2022 peak (see chart below) while also indirectly taming record rent spikes. However, if the U.S. housing market were to heat back up, it could see rising home prices and rents erase progress that the Fed has made on the housing front. And if the Fed can’t tame inflation in a rate sensitive sector like housing, it’d surely struggle with inflation further outside its rate hiking purview.

If financial conditions were to continue to loosen, Kashkari said the Fed would look to use "other tools." The CNBC anchor then asked Kashkari to clarify what he meant by "other tools."

"It'd cause me to say we'd need to do more with the federal funds rate and we also have the balance sheet as well," Kashkari said.

Of course, if the federal funds rate were to rise higher than expected, financial markets would in theory put additional upward pressure on long-term rates like mortgage rates. However, the bigger deal for real estate agents and brokers might be the latter suggestion: The "balance sheet."

See, the Fed's quantitative easing program (i.e. buying bonds) during the pandemic saw the central bank's holdings of Treasury securities climb to $5.4 trillion and mortgage-backed securities climb to $2.6 trillion. If the Fed were to sell-off some of those mortgage-backed securities, in theory, it'd push mortgage rates even higher.

How likely is the Fed to actually sell-off mortgage-backed securities? Right now, it doesn't look like it's in the cards.

While speaking to The Economic Club of Washington on Wednesday, Fed Chair Jerome Powell said offloading mortgage-backed securities isn't currently being discussed.

"We have said that we would consider sales of mortgage-backed securities. But I will tell you that is not something on the list of active things, things actively being considered," Powell said.