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QE2 gives green light for yield in MBS

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Analysts said the decision by the Federal Reserve to purchase another $600 billion of Treasury securities "gives the green light for yield" in mortgage-backed securities, and the central bank may consider purchasing MBS if spreads widen significantly. JPMorgan Securities analysts recommend investors stay somewhat overweight in MBS vs. swaps, but neutral vs. Treasuries, as the Fed's bond-buying plan "will put pressure on swap spreads, but mortgages are poised to outperform swaps." And Bank of America/Merrill Lynch analysts also advise remaining overweight in agency MBS and commercial MBS, as well. Following its meeting the first week of November, the Federal Open Market Committee announced plans to begin another round of purchasing Treasuries "to promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate" of maximum employment and price stability. The Fed plans to acquire $600 billion of the longer-term securities. "But if mortgage spreads were to become dislocated — or if the housing market were to take a sudden turn for the worse — the Fed still has the option to expand its buying into other asset classes, including MBS," JPMorgan analysts said. "Of course, mortgages are not the most ideal asset for the Fed to purchase. They are long-dated assets and there is very little ability to trade them around, without creating a massive dislocation in the market." JPMorgan analysts think the Fed might reinvest maturing MBS into Treasuries to the tune of $300 billion over the next 12 months, if the market warrants as much. Although lack of supply, technicals, and fundamental valuations, are enough for the analysts to advise staying overweight in the MBS basis. "The similarity between the Fed’s QE2 duration target and that of the CMBS market suggest CMBS is especially well-positioned to benefit from QE2," BofAML analysts said. "We recommend moving down to the AA/A level of capital structure for yield pickup and price return." Signs of life are slowing creeping back into the MBS. In October, the Federal Deposit Insurance Corp. announced plans to bring $500 million of CMBS to market before the end of January. And the National Credit Union Administration has begun divesting itself of about $50 billion of troubled assets it acquired upon taking a handful of credit unions into conservatorship. The NCUA has priced a few of an expected 10 or so deals of residential MBS that carry gilt-edged ratings due to full faith and credit pledge of the U.S. government. Write to Jason Philyaw.

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