THE BASIS POINT

2 Weeks and $10b Left In Fed’s $1.25t Rate Stimulus Program. What Now?

This report covers weeks 62-63 of a mortgage bond purchase program by the Federal Reserve—here’s weeks 60-61. In the last two weeks, the Fed bought $20b net of mortgage bonds as follows: $10b March 4-10, $10b March 11-17. For the past 6 months, the Fed has focused most of its weekly buying on 4.5% and 5% coupons (tables below), which represent outstanding loans in the 4.75%-5.125% and 5.375%-5.75% ranges respectively. This makes sense since most of the new bond supply coming to market from new loans being made are at those rate ranges.

Rates are still hovering around 5% on flat inflation data this week, but have moved slightly higher yesterday and today based on improving Leading Economic Indicators data, and the fact that ratings agencies Fitch and Moody’s have said that the U.S. AAA credit rating is at risk. Rates are only about .25% above all-time record lows, but how long will it stay this way?

How Long Will Current Rates Last?
The purpose of the Fed mortgage bond buying program initiated January 1, 2009 is to elevate mortgage bond prices which pushes rates down. We’ve held the position that the record rate low set on November 25, 2009 will remain the record low. The Fed will use up it’s $1.25t budget in two weeks (see program-to-date tally below), then markets will begin to see just how much impact the Fed buying will have on rates.

As the Fed backs off their buying, total mortgage bond supply is also expected to decrease: most estimates call for 2010 loan originations that are 40-50% less than 2009’s. So this could prevent a big rate spike that many think will happen as the Fed ends its mortgage bond buying.

The Fed has also said they’d consider extending the MBS purchase program if necessary.

The intent of the Fed’s program is that private MBS markets will re-emerge as the Fed eases off. For housing and the overall economy to generate self-sustaining recovery, there must be a private MBS market that’s not reliant on the government as a core participant.

Until we get to that stage, rate volatility will continue during 2010. Today, like most days, is no exception. Mortgage bonds were down 22bps and now they’re up 9bps: a 31 basis point swing, and it’s only halfway through the trading day.

What Mortgage Bond Buying Means for Rates And Consumers
If you’re waiting to refinance, your window is closing. If you’re looking to buy a home, rates are important, but a good home price is more important. So buyers shouldn’t let the rate market dictate their strategy—the price and quality of the home should be the driving factor.

Below is an excerpt from a post we did a few weeks ago that answers the question of where rates may go by summer and why:

Rates on loans up to $417,000 are about 5% as of mid-February, and rates could rise as much as .5% by summer for three macro reasons: (1) The Fed will end it’s $1.25t mortgage bond buying program March 31, and then we’ll likely see profit taking on mortgage bonds as private investors sell, which pushes prices down and yields—or rates—up; (2) An improving economy and resulting inflationary fear will cause mortgage bonds to sell off because inflation eats up bond returns, so this would also push bond prices down and rates up; and (3) Inflation will cause the Fed to start hiking short rates from current near-zero levels. Global investors currently borrow on these short-term rates to buy long-term securities with higher returns. When short rates rise, it will erode the benefit of this interest rate trade and force selling of long-term securities—including mortgage bonds—to repay short-term loans. That selling will also push rates higher.

Tally Of Mortgage Bonds Bought By Fed
The Fed, according to their own reporting, has bought $1.239t net of mortgage bonds, which is 99.12% of their allotted $1.25t target by March 31, 2010. This isn’t an official number, it is a close tally The Basis Point has kept of weekly net MBS purchases since the Fed began buying in January 2009. Here’s the current and detailed report of the Fed’s MBS holdings.

MBSmarch4to10
MBSmarch11to17