- Jonathan Poyer
The cure to high prices is…high prices?
Since launching its bond-buying program in March 2020, the Fed’s $40B/month Mortgage Backed Security (MBS) purchases has bought a significant amount of MBS totaling around $500B. The Fed owns about a third of the treasury and mortgage markets.
MBS are investments based on pools of home mortgages; in essence, investors are buying a claim to the cash flow coming from these mortgage debts. Thus, investors are lending money to homeowners and getting back money in the form of mortgage payments.
Among MBS, there are basically two types:
Agency MBS - Created by government or quasi-government agencies.
Non-Agency MBS - Created by private entities.
The Fed purchases agency MBS. Agency MBS are generally viewed as a rates product, so for example, the on-the-run Agency MBS coupon probably has around a 5-6 year duration.
It has been said that the Federal Reserve is going to speed up their “tightening” and “easing” programs as it relates to their purchase of agency MBS.
In November, they began reducing the size of bond purchases.
In December, the Fed announced that they would decrease their MBS purchases at a faster rate. This did not apply to the Fed’s reinvesting proceeds. The Fed would continue replacing MBS investments that would otherwise fall off the balance sheet.
On January 5th, from the Fed’s December meeting minutes, the committee discussed capping monthly reinvestments. Thus, actively shrinking their MBS holdings. A change in the game!
Mortgage rates are taking a hit (increasing) because, for one instance, they are more reliant on Fed bond buying than treasuries and the Fed stated a preference to hold only Treasuries in the future. That means, not only no longer purchasing new MBS but actively capping their monthly reinvestments and thus selling off or shrinking their holdings.
We can talk about what this means for market collateral at another time.
If the Fed is no longer back-stopping the market, then the issuers of loans will need higher rates of interest as they will be taking on more risk. Thus, higher mortgage rates. How that will impact purchasing power in the economy is not quite evident today. However, I would guess that this will greatly strain purchasing power in the not too distant future. That could have a material impact on the economy and growth.
Mortgage rates are most likely going to continue to increase as the Fed raises rates. The average 30-year fixed rate has already moved from 2.7% to 4.7% in just a few months. If the Fed is targeting 2%, we could see the 30-year fixed rate getting close to 6.5% - 7%.
The cure to high prices is…high prices.