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Fed likely to continue MBS purchases to secure housing recovery

The Federal Open Market Committee has another distinct opportunity in its latest Federal Open Market Committee statement to argue its third-round of open-ended quantitative easing is working, according to Bank of America Merrill Lynch (BAC).

The FOMC wraps up the meeting today and will release the minutes weeks from now, but analysts already expect ongoing FOMC support for mortgage-backed securities purchases.

While the December FOMC minutes had investors questioning the Fed policymaker’s commitment to mortgage-backed securities purchases through QE3, BofAML analysts said the Fed will continue to support the program. 

“Prematurely withdrawing from the MBS markets could threaten to derail nascent progress in the broader goals of refinancing high risk borrowers, normalizing the mortgage banking industry and ensuring a sustained recovery in home prices,” analysts said.

As a result, these goals support the Fed’s overall objective of improved labor market conditions and stronger economic growth.

Similarly, Goldman Sachs (GS) projects the Fed is likely to continue purchases of Treasuries and MBS securities past market projections. The company expects QE3 to continue through 2014.

More than 2.5 million high-risk borrowers are still eligible for the Federal Housing Finance Agency’s Home Affordable Refinance Program as well as the Federal Housing Administration’s grandfathered Mortgage Insurance Premiums (MIP) programs, BofAML noted.

It would take all of 2013 to process these borrowers, which would require low mortgage rates to prevail through the year at the current monthly rate of refinancings.

Also, increased traction is ongoing as evidenced by recent servicing transfers and service capacity build out.

“This is understandably a lagged process that the Fed leadership likely recognizes,” the report stated.

Additionally, BofAML analysts noted that low mortgage rates are critical to normalizing the mortgage banking industry. QE3 has assisted a capacity build out and restarted competition, which are both “necessary for a tightening in primary as well as secondary spreads,” the BofAML report said.

Thus, scaling back from the program is expected to undo the progress that has been made.

Currently, primary and secondary spreads are at 111 basis points and have room to tighten another 20 basis points, barring further guarantee-fee increases. However, they have compressed from much wider levels that prevailed through the back-end of 2012.

Normalization of the mortgage banking industry also is required to further support the housing recovery.

President Eric Rosengren at the Boston Federal Reserve is one of the members supporting continued MBS purchases.

“Particularly at a time when housing prices are beginning to rise in many markets, making mortgage rates attractive may encourage potential home buyers to not delay their purchase decision,” he said.

However, Rosengren’s views are not uniformly shared within the FOMC and as a result, more debates about QE3 are expected to continue as the year progresses.

Nonetheless, BofAML does not expect the Fed to prematurely withdraw from the current purchase program given its success thus far.

Econoday also expects the FOMC to leave policy rates unchanged.

“The Fed is paying more attention to unemployment currently than to inflation. So, comments on the labor market could move financial markets,” analysts said.


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