Everyone including the home buyers got worried by the recent talk at the FED about the reduction of its mortgage backed securities (MBS) holdings. Fed holds $1.75 trillion of MBS from quantative-easing program. The Fed owns Treasuries including $1.75 trillion of MBS from quantative-easing program as part of its $4.45 trillion of assets. Unlike Treasuries, the Fed rarely owned mortgage-backed securities before the financial crisis. Over the years, its purchases have been key in getting the housing market back on its feet. Along with near-zero interest rates, the demand from the Fed reduced the cost of mortgage debt relative to Treasuries and encouraged banks to extend more loans to consumers.
Lawmakers, although, have for long criticized the MBS holdings of FED and have criticized the investments as beyond what’s needed to achieve the central bank’s mandate. But since the Fed is now the biggest source of demand for U.S. government-backed mortgage debt and owns a third of the market, any change in FED’s position is likely to increase costs for home buyers.
The Fed bought $387 billion of mortgage bonds in the past one year just to maintain its holdings. In a roughly two-year span that ended in 2014, the Fed increased its MBS holdings by about $1 trillion, which it has maintained by reinvesting its maturing debt. Getting out of the bond-buying business as the economy strengthens could help lift 30-year mortgage rates past 6 percent within three years, according to Moody’s Analytics Inc. Unwinding QE “will be a massive and long-lasting hit” for the mortgage market, said Michael Cloherty, the head of U.S. interest-rate strategy at RBC Capital Markets. He expects the Fed to start paring its investments in the fourth quarter and ultimately dispose of all its MBS holdings.
The move to taper its investments has the potential to cause further tightening. Morgan Stanley estimates that a $325 billion reduction in the Fed’s MBS holdings from April 2018 through end of 2019 may have the same impact as nearly two additional rate increases.
“The biggest buyer is leaving the market, so there will be less demand for MBS,” said Marty Young, fixed-income analyst at Goldman Sachs. The firm forecasts the central bank will start reducing its holdings in 2018. That’s in line with a majority of bond dealers in the New York Fed’s December survey.
However, the plus point of this is that getting MBS back into the hands of private investors could help make the market more robust by increasing trading. Average daily volume has plunged more than 40 percent since the crisis, Securities Industry and Financial Markets Association data show.
“Ending reinvestment will mean there are more bonds for the private sector to buy,” said Daniel Hyman, the co-head of the agency-mortgage portfolio management team at Pacific Investment Management Co.
Also, it may give the central bank more flexibility to tighten policy, especially if President Donald Trump’s spending plans stir more economic growth and inflation. St. Louis Fed President James Bullard said last month that he’d prefer to use the central bank’s holdings to do some of the lifting, echoing remarks by his Boston colleague Eric Rosengren.
The “Fed has already hiked twice and the market is expecting” more, said Munish Gupta, a manager at Nara Capital, a new hedge fund being started by star mortgage trader Charles Smart. “Tapering is the next logical step.”
Mortgage rates have started to rise as the Fed moves to increase short-term borrowing costs. Rates for 30-year home loans surged to an almost three-year high of 4.32 percent in December. While rates have edged lower since, they’ve jumped more than three-quarters of a percentage point in just four months. The surge in mortgage rates is already putting a dent in housing demand. Sales of previously owned homes declined more than forecast in December, even as full-year figures were the strongest in a decade, according to data from the National Association of Realtors.
People are starting to ask the question, “Gee, did I miss my opportunity here to get a low-rate mortgage?” said Tim Steffen, a financial planner at Robert W. Baird & Co. in Milwaukee. “I tell them that rates are still pretty low. But are rates going to go up? It certainly seems like they are.”
Conclusion is that this FED’s imminent quantitative easing experiment will be having repercussions for the U.S housing market recovery and its consequences for the U.S. housing market of can’t be ignored.