The Federal Reserve Bank of New York said on Monday morning that it had begun buying mortgage-backed securities guaranteed by Fannie Mae (FNM), Freddie Mac (FRE) and Ginnie Mae as part of an earlier announced $500 billion program. The Fed had announced on Nov. 25 that it would initiate a program to purchase up to $100 billion GSE direct obligations and $500 billion MBS backed by the agencies in an effort to replace waning demand from foreign and other more traditional buyers of mortgage bonds. MBS prices popped in very early trading Monday, as a result — the FNMA 30-yr 4.5 was seen trading at 101.20 at one point early Monday morning, up 20/32 — before retreating slightly to a more modest gain (prices were +16/32 when this story was published). Longer-term Treasuries, however, saw prices fall (and yields rise) amid speculation that the government will look to sell $50 billion in Treasuries this week as part of an effort to lessen the recession’s bite. The yield on the 10-year note had increased seven basis points, or 0.07 percentage point, to 2.41 percent by 10am EST Monday morning, Bloomberg reported. In an announcement over the holidays, the Fed suggested that its purchase program will run through the second quarter — a much tighter window than most analysts had projected. “When the Fed initially announced the plan to buy agency MBS in November, they indicated that $500 billion agency MBS will be purchased in ‘several’ quarters and the market interpreted ‘several’ quarters to mean that these purchases will occur in no less than four quarters,” analysts at Bank of America (BAC) wrote last week. “Obviously, this change in language indicates a lot stronger short-term support to the agency MBS market than originally assumed.” “The potential size of the Fed’s purchase program can take down most of the 2009 agency MBS net supply,” analysts Derek Chen and Nicholas Strand at Barclays Capital said in a research report. Both Chen and Strand believe the Fed program could drive primary mortgage rates down to 4.5 percent, stimulating further refinancing activity, although a huge refi boom — last seen in 2003 — isn’t likely without looser underwriting. Under the program, only fixed-rate agency MBS securities are eligible assets for the program, including 30-year, 20-year and 15-year securities. The program does not include CMOs, REMICs, Trust IOs/Trust POs and other mortgage derivatives or cash equivalents, a program information sheet said; the Fed will trade in specified pools, TBA transactions, and in the dollar roll market. BofA strategists last week had singled out the use of dollar rolls as “a positive development for the pass-through market, as it will bring back some semblance of normalcy to the roll market in 2009.” Of course, the challenge here is funding the MBS purchase program, which the government has said it intends to do by printing more money; as we noted last week, we agree with other strategists who have suggested that such an approach should have market participants focused on a potential inflationary response towards the back half of next year, as a result. Printing money does have a cost associated with it, after all. Write to Paul Jackson at [email protected].

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