Mortgage Investors Don’t Think Fed’s Exit Means Goodbye Forever

(Bloomberg) -- Mortgage investors are taking the coming end of the Federal Reserve’s mortgage-backed securities purchases calmly for good reason. They don’t believe it’s gone forever.

“Once the Fed crossed the Rubicon into QE, they are never going to go back,” according to Walt Schmidt, head of MBS research at FTN Financial, whose advisory group has $17 billion in agency mortgage-backed securities and collateralized mortgage obligations under management.

The Fed’s vast MBS holdings, currently $1.709 trillion, have helped drive mortgage rates to record lows, dampen volatility and boosted home prices and related securities. It’s widely forecast that by October the central bank will no longer reinvest any proceeds back into mortgages, and that should widen spreads.

The Federal Reserve is currently in the midst of “normalizing” its balance sheet by allowing its MBS holdings to run off. Investors may take comfort in the promise made in the FOMC minutes from its June 2017 meeting:

“The Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate”
Mortgage Investors Don’t Think Fed’s Exit Means Goodbye Forever

To be sure, should QE be reintroduced mortgages might not be the Fed’s first choice. “I don’t think it’s something the Fed wants to do as a normal course of business,” said Matt Jozoff, head of JPMorgan’s securitized products, rates and municipal research. “If they were to resume QE they would much prefer to focus on Treasuries rather than mortgages.”

Fannie Mae 30-year current coupon spreads have only widened 12 basis points so far this year to 0.81 percent and the idea of a central bank prepared to reenter the MBS market may be one reason.

“The MBS market knows that in the next crisis they will do it again if they have to. This is very important and why I don’t see spreads gaping out even if we get a little realized volatility,” Schmidt said.

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