Fed Still on MBS Buying Spree
The Fed continues to purchase large volumes of mortgage-backed securities (MBS) from government-sponsored enterprises. The move is a response to improved financial market conditions in recent weeks, culminating with the release of the stress test results calculated under the Supervisory Capital Assessment Program, according to the Federal Reserve, which then reduced efforts to extend credit under its liquidity programs. The Fed now holds $428bn in MBS on its books as of May 27 since it started buying the securities the first week of the year. The Fed lists its purchases with settlement dates up to several months in the future, staggering the effect on its balance sheet, according to the Fed's first monthly report on credit and liquidity programs and its balance sheet, released Wednesday. "The Federal Reserve determined that supporting the mortgage-backed security 'dollar roll' market promotes the goals of the mortgage-backed securities purchase program," Fed officials said in the report. "Dollar roll transactions," the Fed added, "which consist of a purchase of securities combined with an agreement to sell securities in the future, provide short-term ?nancing to the mortgage-backed securities market. Because of principal and interest payments and occasional delays in the settlement of transactions, the Federal Reserve also has some uninvested cash associated with the mortgage-backed securities purchase program." According to one Bank of America (BAC) analyst, the Fed's MBS purchasing power still has room to grow. Under a scenario with higher rates (10-year Treasury yield at 4.5%), mortgage spreads would widen unless the Fed purchases more than 50% of all new MBS issuance, says the analyst. By the same token, under a scenario with lower rates (10-year Treasury yield at 3.25%), agency MBS would perform "extremely well" if the Fed were to buy 50% of all new agency MBS issuance. Such analysts adjust outlooks as goals and expectations of the Fed's MBS purchase program change. The BofA analyst pointed toward comments from Federal Reserve Bank of New York president William Dudley that indicate the Fed's ultimate goal of the program. "With MBS, our goal is to be a significant portion, say more than 50%, but less than 100%," Dudley told the Economist.com. "To the extent yields back up and mortgage origination slows, we might want to slow our purchase programme because we don't want to be 150% of the private market. We would displace all the private-sector players...and we'd become the market." The statement marks a departure from a wide-held belief among analysts that the Fed's goal was only to keep mortgage rates low for most of 2009, says the BofA analyst. It also illustrates the Fed, while actively engaged in buying up billions of dollars in agency MBS, has no intentions to take over the market. Write to Diana Golobay. Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments.