Fed Mortgage Bond Program, September 17-23 (week 38)

This week was the 38th week of a mortgage bond purchase program by the Federal Reserve—here’s week 37. Between September 17 and September 23, the Fed bought $23.03b net of mortgage bonds—below is a table breaking down the amounts for each coupon and maturity across the three agencies that issue these securities: Fannie Mae, Freddie Mac, and Ginnie Mae. For the sixth week in a row, the Fed focused buying primarily on 5% and 5.5% coupons which represent outstanding loans in the 5.375%-5.75% and 6.0%-6.25% ranges respectively.

After six weeks of the lowest rates since mid-May, rates rose slightly this week on Fed news about this mortgage bond program and on mediocre Treasury auction results. And the huge development this week was the Fed’s announcement that they’d extend this program timeline (but not budget) to March 31, 2010—more on this below.

The Fed has been using their mortgage bond buying program all year to elevate mortgage bond prices which pushes rates down. Factors affecting rate levels are which coupons the Fed buys weekly and how much, amount of private selling pressure their is working against Fed buying, and how much mortgage and Treasury bond supply is coming onto the market.

This week brought $112b in 2yr, 5yr, and 7yr issues to market and while sentiment didn’t fully reflect oversupply concerns, the auction uptake wasn’t as good as two weeks ago. This week the Fed said they’d extend the timing of their mortgage bond purchase program from December 31, 2009 to March 31, 2010, but wouldn’t increase the $1.25t budget. Same budget over a longer time horizon means markets can expect fewer purchases per week to prop up mortgage bond prices and lower yields (or rates).

As we approach the end of 2009 and move through 1Q2010, we’re likely to see private mortgage bond investors trimming positions which also creates upward rate pressure. We’ve held the position since March that further significant rate drops as a result of Fed mortgage bond buying don’t seem likely because rates have already dropped to historical lows. The money manager strategy since the Fed MBS program was announced in November 2008 has been to buy MBS ahead of Fed buying and sell at a profit before the Fed does.

So if the money mangers start selling mortgage bonds as we get closer to March 31, 2010 and the Fed closes in on their $1.25t mark, and also the Fed starts selling when the economy improves, that will create potentially sharp upward rate pressure. This new timeline doesn’t only lessen the Fed’s rate lowering impact but also private selling will create additional upward rate pressure.

To extend the timeline without extending the budget, the Fed is likely to do one of two things: (1) buy less per week, so instead of buying about $25b in MBS per week like markets are accustomed to now, that would go down to about $20b or less, or (2) buy in bigger bulk every other week. Only time will tell, but either way, it will probably lead to even more rate volatility than we’ve seen all year.

Market sentiment shifts wildly as all global market participants furiously try to reconcile where we’re headed. The rate spike that began late-May and ran through June was caused by mortgage bonds selling off on bond market oversupply concerns—these concerns were driven by Treasury issuance than began when summer kicked off. The Treasury issuance has been to raise money for the nearly-$1t stimulus package passed earlier in 2009.

As Treasury issuance continues, so does the feeling that most regions globally are through the worst of the recession, which can push money back into stocks. And now markets will contend with changing bi-weekly Fed participation as well as Fed phase-out.

What Mortgage Bond Buying Means for Rates And Consumers
We cover the Fed mortgage bond buying weekly to try to help consumers make decisions but the gist is: rates are at all-time lows, so if you can get the right price on a property purchase you’ll get a record low rate to go with it. And if you’re looking to refi, your window is closing. Once the Fed passes over 75% of their budget in the coming weeks, we’re likely to see rates rise as private mortgage bond investors sell holdings.

Also see this report for a detailed description of the Fed program and what it means for consumers, keeping in mind the rates referenced in that piece are dated (and rates change all day everyday as mortgage bonds trade).

Tally Of Mortgage Bonds Bought By Fed
The Fed, according to their own reporting, has bought $894.65b net of mortgage bonds, which is 71.57% of their allotted $1.25t target by March 2010. This is a tally The Basis Point has kept of net MBS purchases since the Fed began buying in January 2009. Here’s the current and precise report of the Fed’s MBS holdings.