Mortgage applications contracted after seeing interest rates rise from higher Treasury yields that followed an optimisitc reading of the U.S.' economic recovery by the Federal Reserve.

According to the Mortgage Bankers Association’s (MBA) weekly report, mortgage application volume fell 1.1% last week from the previous week. Mortgage applications had previously risen 5.5% in the MBA’s last report, which made up for the slump in the market seen after Labor Day.

The average contract interest rate for 30-year, fixed-rate mortgages with conforming loan balances of up to $548,250 increased to 3.10% from 3.03%.

Applications to refinance a home loan decreased 1% from last week's report. However, it is possible that after running flat from a year ago, an increase in interest rates on mortgages could portend more negative effects on demand for refinancing next week.

Joel Kan, the MBA's chief economist, told CNBC that "increased optmism about the strength of the economy pushed Treasury yields higher" after a meeting of the Federal Reserve's Open Market Committee (FOMC). Kan added that mortgage rates rose in response across all loan types with 30-year fixed rates reaching a peak not seen since July 2021.

Federal Reserve Chairman Jerome Powell said last week that the central bank was confident enough in the direction of the U.S. economy that it could soon begin tapering off the multibillion-dollar asset purchases it has made since the start of the pandemic.

The long-term interest rates were left untouched after the FOMC meeting, something Powell, a monetary dove, said previously that he would not be acting too soon to change.

As mortgages contracted, the housing market has been suffering from a mismatch of high demand and low supply.

According to the S&P CoreLogic Case-Shiller 20-City Index, home prices showed a 19.7% annual gain in July and the smaller 10-City Index also saw an increase in price by 19.1% from 18.5% only a month earlier. The rise in home prices is pushing applications for larger mortgages ahead of smaller applications, according to MBA’s Kan.

“With home-price appreciation continuing to run hot, increasing more than 19 percent annually in July, applications for larger loan amounts continue to outpace lower-balance loans. The average loan size for a purchase application reached $410,000, its highest level since May 2021,” Kan said.

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