End of MBS Purchase Program

End of Fed’s $1.25 Trillion Mortgage Backed Purchase Program: The Effect On 30 Yr Mortgage Rates

Timeline:

November 25, 2008: The Federal Reserve Initiates Mortgage Purchase Program

Fed announces that it will initiate a program to purchase the direct obligations of housing-related government-sponsored enterprises (GSEs)--Fannie Mae, Freddie Mac, and the Federal Home Loan Banks--and mortgage-backed securities (MBS) backed by Fannie Mae, Freddie Mac, and Ginnie Mae.

Purchases of up to $500 billion in MBS will be conducted by asset managers selected via a competitive process with a goal of beginning these purchases before year-end. Purchases of both direct obligations and MBS are expected to take place over several quarters. Further information regarding the operational details of this program will be provided after consultation with market participants. link

March 18, 2009: The Federal Increases Mortgage Backed Securities Purchase Program

To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. link

September 18, 2009: “The Fed’s cumulative MBS purchases have reached $840.1 billion, and it has announced plans to purchase up to $1.25 trillion by the end of the year.” link

December 14, 2009: Fed MBS Purchases: Over 85% Complete: “In the last two months, the average weekly amount of MBS purchased has been smaller, averaging $17 billion over the last 10 weeks versus the average of $23.4 billion before that period.” link

January 10, 2009: Fed MBS Purchases: 90% Complete link

January 28, 2009: Fed MBS Purchases by Week: link

Current Spread between Fannie Mae 30 Yr Historical Required Net Yields (link) – 10 Yr Treasury Bond (link)

Spreads
Current 10 Yr Treasury Rate: 3.61%

12/03/2007 to 11/25/2008: 2.091644
11/26/2008 to 01/29/2010:1.455505
Current Spread (Jan 29, 2010):1.13166

Articles:
June 5, 2009: (link) Rising Rates: The Next Fed Meeting Will be Interesting“This graph shows the relationship between the Ten Year yield (x-axis) and the 30 year mortgage rate (y-axis, monthly from Freddie Mac) since 1971. The relationship isn't perfect, but the correlation is very high. Based on this historical data, a Ten Year yield at 3.84% suggests a 30 year mortgage rate of around 5.75%.”

September 17, 2009: (link)“Sure enough mortgage rates have been below expectations for a number of months (the last 5 months in blue triangles). Although this is a limited amount of data - and the blue triangles are within the normal spread - this suggests the Fed's buying of MBS is reducing mortgage rates by about 35 bps.”

January 5, 2010: (link)

Pimco's Bill Gross Sees 2010 as Year of Reckoning

What does this say about the Federal Reserve's hopes to start pulling its added liquidity out of the markets, either by raising short-term rates or just getting out of buying bonds, which has been keeping long rates low?

I think the Fed's statements suggest that they really want to exit in some fashion from the buying program. The first step in that direction, logically, would be to stop buying, and our sense is that they're at least going to try that. But based on our forecasts for the second half of the year, they may have to reinitiate it, and that will be difficult to do once they stop because it then becomes a political hot potato.

All that said, I think they'll stop buying mortgage-agency securities, and the trillion-and-a-half-dollar check that's been written over the past nine to 12 months basically disappears. It's significant from the standpoint of interest rates and interest-rate spreads in certain sectors. And I would even go so far as to say it might be a mistake.Won't that put upward pressure on interest rates?I think it will. I mean, the mortgage market would be your first place to look, in terms of something that's overvalued that would become normalized. Nobody knows what the Fed's buying is worth — we think about half a percentage point on rates, but we don't know.

Won't that put upward pressure on interest rates?

I think it will. I mean, the mortgage market would be your first place to look, in terms of something that's overvalued that would become normalized. Nobody knows what the Fed's buying is worth — we think about half a percentage point on rates, but we don't know.

(emphasis mine)

January 29, 2010: (link) : Fed's Kohn says impact from end of Fed MBS purchases matter of uncertainity

Says:

- predicting Fed policy impact on rates especially hard

- especially important for banks to limit rate risk

- impact from ending MBS purchases likely to be modest- ‘volatilities’ unlikely to return to ‘quiescent state’- foreign capital may decline for US in coming years

Comments From Dan:
On the one hand we have comments from Calculated Risk blog (35 bps rise), Bill Gross of Pimco (50 bps), and the Fed’s Kohn indicating a relative modest increase in rates once the Fed’s MBS purchase program is completed. Based on a 35 bps to 50 bps rise in mortgage rates, this would point to a 30 Year Fixed mortgage rate of roughly 5.250% to 5.625%, based on recent mortgage rates (4.75% on a 30 Year Fixed Rate Mortgage).

However, if we applied the average spread from the time period preceding the MBS program, and experience an average spread of 2.09%, this would imply a slightly higher rate range, from 5.750% to 6.125%.

The risk, and in my opinion it is a significant risk, is that the comparison’s being made in the pre-Nov ’08 MBS period, had a significantly lower foreclosure/default rate. It would not be surprising to see the spread between 10 Yr Treasuries and 30 Yr Mortgage rates to initially spike to the higher end of the boundaries (the Nov 20, 2008 spread was 2.739%, which would imply a 30 yr mortgage rate in the 6.375% to 6.500% range, based on the 01/29/2010 close at 3.61% on the 10 Yr Treasury), in order to account for higher foreclosure/default risk.

In my opinion, I have not seen forecasts which adequately adjust for foreclosure/default risk in the projection of rates after the purchase program ends. My personal opinion is that it would not surprise me to see spreads widen beyond the upper bounds of the spread in the pre-Purchase sample period, i.e. above a 2.739% spread. It is conceivable that we could see 30 Year Fixed Mortgage Rates approaching 7% after the end of the Fed’s MBS Purchase Plan, even with a relatively flat Treasury yield.