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Waiting game: Investors prepare for Fed MBS tapering

Credit market and mortgage bond investors now view the central bank’s continued supportive stance (quantitative easing) as dependent upon continued weak economic data. This, by extension, means that the timing of the Federal Reserve tapering of mortgage-backed securities is becoming less predictable, analysts claim — based on continued improving economic fundamentals.

Time to price it in, they say.

It’s now a familiar dynamic for homebuilding investors – the positive effect of better economic data is offset by its potential to lead to higher rates, thus causing the market to see-saw between good and bad news, according to Barclays.

“It is our view that concerns of a material spike in the 30-year mortgage rate are somewhat premature, and that long rates will likely remain range-bound until Fed tapering is imminent – probably closer to year-end,” analysts at Barclays (BCS) stated.

In the mean time, a strong wave of upward estimate revisions over the remainder of the year will dominate the trading action in the homebuilding stocks.

Barclays’ economists believe Fed asset tapering will begin in the first quarter of 2014, and a rise in the Fed’s funds will begin in the first quarter of 2015.

Ben Bernanke, chairman of the Federal Reserve, made it clear that tapering its open-ended third round of quantitative easing program before the economy is on solid footing would be a tremendous setback. 

The chairman made it clear that the central bank is prepared to increase or reduce the pace of its asset purchases to ensure that the stance on monetary policy remains appropriate.

Nonetheless, “Withdrawing policy accommodation at this juncture would be highly unlikely to produce such conditions. A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further,” Bernanke explained.

On a similar note, Goldman Sachs (GS) believes the Federal Reserve will continue purchases of Treasurys and MBS past market projections. 

The market is expecting an ending to QE3  in mid-to-late 2013, but the banking giant expects the program to continue through 2014.

Similarly, strategists for Bank of America Merrill Lynch (BAC) are confident members of the Federal Open Market Committee will stay committed to 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.

However, some market experts remain less cautious about the impact of tapering QE3, based on widespread improvements in securitization and the shadow banking system that helps provide the needed liquidity.

“With improving credit quality, more conservative structures and far greater scrutiny, the return of securitization and shadow banking may lessen the blow when the Fed starts tapering their bond buying program,” said ()NewOak Capital.

Frischling adds that technological investments along with heightened regulatory oversight also help provide the necessary risk buffers in the secondary markets.

“Private equity firms along with other non-bank financial intermediaries will benefit from the continued growth of the shadow banking system,” he added. “Fortunately, if executed properly, so too will the economy.”

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