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Investments

Bank of America quants issue mortgage rate warning

Troubles with the taper

May 5, 2014
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Analysts at Bank of America Merrill Lynch are making an interesting argument on whether or not the Federal Reserve should consider putting a temporary halt on the taper.

Spoiler alert: The securitization researchers don't think a halt to the taper will actually happen, but offer supporting evidence that maybe it should.

For one, the lack of negative headlines around payrolls and jobs numbers help support the decision to continue to reduce the purchase of Treasurys and mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae.

As I noted just last week, a more important signal that the economy is facing trouble is the fact that the government cooked its books to achieve a slightly positive GDP number.

Yet as the taper continues, so will the reversal of mortgage rate compression this type of monetary policy brings.

"Weak underlying economic strength, however, suggests the economy is too weak yet to sustain the impact of higher rates," the analysts state.

"Despite speculation running high on a halt in the taper, none of the above is likely to change the Fed’s intent to continue to taper straight into the fall. Hindsight may prove that the decision to taper was premature," they added.

Furthermore, as the Fed continues to slow its Treasurys purchases, this undermines the technical picture somewhat, through an increased supply of the longer-duration products.

The BofAML analysts then warn that all this is happening in an environment of a Fed withdrawal, something that hasn't happened before, so it's hard to predict the long-term impact of keeping with the taper schedule of $10 billion less each Fed meeting.

 But, undaunted by these challenges, the quants provide the following prediction anyway:

"Should these technicals deliver higher Treasury yields, higher mortgage rates would lower mortgage originations, feeding back towards weakening housing," the analysts claim.

"While too early to see how this nets out, it only underscores the importance of housing and purchase money trends over the summer," they add. "Evidence thus far suggests an economic fog setting in."

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