As we count down to the end of March, many are eagerly waiting to see the market reaction to the Fed ceasing its purchases of $1.25 trillion in mortgage-backed securities. Most believe it inevitable that rates have nowhere to go but up … it’s just a matter of when and the degree of influence that this Fed move will have on the timing. Estimates of rate increases currently range from a .25% to .75% increase in mortgage rates.
Now, we must note that stopping purchases is altogether different than re-selling them on the open market. Selling MBSs would serve to reduce the Fed’s extended balance sheet, while sucking liquidity out of the market. Recent Fed statements indicate that this strategy, however, is highly unlikely in the near future.
“I currently do not anticipate that the Federal Reserve will sell any of its security holdings in the near term, at least until after policy tightening has gotten under way and the economy is clearly in a sustainable recovery. However, to help reduce the size of our balance sheet and the quantity of reserves, we are allowing agency debt and MBS to run off as they mature or are prepaid.”
These statements have fueled some optimism among rate watchers, who believe that post-March rates will barely ripple. They point to the Fed nearly halving its weekly net MBS purchases from $21 to $12 billion recently, while maintaining smaller MBS vs. Treasury spreads than when the Fed announced extending its purchase program last September.
The bottom line is that the Fed can step back in if need be, and it will do all it can to keep rates low until signs of sustainable economic growth kick in. As for how much rates will jump, ‘care to place your bets?
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Here is a recent article dealing precisely with gauging the impact on rates:
http://www.calculatedriskblog.com/2010/02/fed-mbs-purchases-and-impact-on.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+CalculatedRisk+%28Calculated+Risk%29&utm_content=Google+Reader
so here’s my take – the fed leaves rate untouched for some time, perhaps raises it 25bps to see what kind of reaction it gets from the market, if good, they sit tight, if not so good they could pick up again buying mbs’s; albeit at a much slower pace – goodness, they already have half the countries mortgages (perhaps that’s not the actual picture but you get the idea) on their balance sheet. But here’s my big prediction, they don’t take any major steps to that program until the wizards in Washington establish parameters on the trading of Credit Default Swaps (CDS). This is the product that made many people wealthy betting on failure. If the wizards accomplish this in the near term than true investors can step back in and purchase mbs’s for the appropriate purposes. Let’s watch and see how this shapes out.