Will the Fed stop buying mortgages? – Orange County Register
When the Federal Reserve begins to scale back its massive bond purchases, mortgage traders are betting that their market will be on the front line.
This would be a break with the Fed’s balanced approach during its last retreat in 2014, when it slowed purchases of government bonds and mortgage-backed securities at the same pace. But with house prices now rising and lending rates not far from record lows, some see diminishing reason for the central bank to continue adding $ 40 billion a month in mortgage bonds to its balance sheet.
It’s a prospect that’s already making waves in the financial markets as traders seek to stay one step ahead of the Fed’s moves. Mortgage-backed securities lost 0.18% last month despite government bonds rising, the worst underperformance since the beginning of the pandemic in January 2020. Last week Robert Kaplan, president of the Dallas Federal Reserve Bank, underscored that view, saying he doesn’t believe the real estate market needs as much support as it gets from the central bank.
“We don’t see any real estate issues that the Fed should be concerned about – on the contrary, it is roaring in certain parts of the country,” said Jake Remley, senior portfolio manager at Income Research + Management. which manages $ 90 billion and reduces exposure to parts of the mortgage market that would be hardest hit by a Fed slowdown. “If the Fed is worried about inflation and wants to do something, it should get out of mortgages and invest more in government bonds.”
The Fed’s intervention in the housing market has long been controversial, although it began in 2008 after the collapse of the housing bubble that weighed on the industry for years.
This time around TheFed has helped push mortgage rates to record lows. Property values have risen along with the Fed’s purchases, with statewide house prices up 13% year-over-year in March, the steepest since 2005.
Certainly, Fed Chairman Jerome Powell has not indicated that the central bank is targeting the mortgage market, nor has he indicated when it will scale back its bond purchases. But a withdrawal from mortgage bonds would give officials more bandwidth to support the treasury market – just like President Joe Biden is trying to enact large spending plans, including a national infrastructure program.
The Fed’s government bond purchases helped reduce interest payments on government debt over the past fiscal year, even as bond issues to fund pandemic aid rose. And Treasury Secretary Janet Yellen said the low cost of debt servicing will give the government leeway to carry out its agenda. The Congressional Budget Office has projected a deficit of $ 2.3 trillion for fiscal 2021 after hitting more than $ 3 trillion last year. These are the largest deficits in relation to the size of the economy since World War II.
“The Fed will take a different approach this time around,” said George Goncalves, head of US macro strategies at Mitsubishi UFJ Financial Group. “It is modulated. And given the budget deficits we have, the treasury market needs the most support.
Speculation that the Fed might announce plans to adjust monetary policy in the coming months was caught on Thursday after new data showed that US consumer prices rose faster than most economists had predicted over the past month. This drove up 10-year breakeven rates, a proxy for the annual inflation rate that is expected over the next decade.
In addition to buying mortgages, the Fed added $ 80 billion worth of US Treasuries to its balance sheet every month. While it was announced that it would maintain this pace, minutes of its April meeting reported that a number of attendees said it might be appropriate to discuss a cut if the economy continues to make “rapid progress”.
Walt Schmidt, head of mortgage strategies at FHN Financial in Chicago, said the Fed could use one of its meetings later this summer – or the August meeting in Jackson Hole, Wyoming – to discuss its plans to slow its bond purchases.
Purchases since the pandemic have pushed the Fed’s mortgage holdings to around $ 2.2 trillion, far more than in previous rounds of quantitative easing. It focused on newly issued mortgage debt, which helped push the 30-year fixed rate loan rate to a record low of 2.65% in January. Net issuance of agency mortgage-backed securities in 2020 more than doubled year over year, reaching $ 508 billion, its highest level since the housing bubble hit in 2007.
But not everyone is convinced that the Fed will pull out of the mortgage market first. While this is a possible scenario that may allow the central bank to focus on government bonds, it is unlikely, says Alex Roever, head of US interest rate strategy at JPMorgan Chase & Co. He said the most cautious approach would be if the Fed follow the 2014 model.
“This is the path we think they are most likely to take because it’s the easiest to communicate with and doesn’t necessarily have unintended consequences,” said Roever.
But Boston Fed President Eric Rosengren also sounded open last month to reducing mortgage bond purchases faster than government bonds in due course because he failed to see that the sector needed further support from the Fed.
“There is a debate about the composition of the balance sheet regardless of the state of the real estate market,” said former Fed Governor Randall Kroszner, who is now a professor at the Booth School of Business at the University of Chicago. “I think the potential for the Fed to pull out of mortgage-backed securities faster than government bonds is on the table.”