Dealers See Fed Buying $545B Mortgage Bonds

Fed Chairman Ben S. Bernanke and his fellow policy makers, who bought $2.3 trillion of Treasury and mortgage-related bonds between 2008 and June, will start another program next quarter, 16 of the 21 primary dealers of U.S. government securities that trade with the central bank said in a Bloomberg News survey last week. The Fed may buy about $545 billion in home-loan debt, based on the median of the 10 firms that provided estimates.

While mortgage rates are already at about record lows, housing continues to constrain the economy, with the National Association of Realtors saying in Washington last week that the median price of U.S. existing homes dropped 4.7 percent in October from a year ago. Borrowers with a 30-year conventional mortgage would save $40 billion to $50 billion annually in aggregate if they could all refinance into a new loan with a 3.75 percent rate, according to JPMorgan Chase & Co.

“We need to see a bottom in home prices,” said Shyam Rajan, an interest-rate strategist in New York at Bank of America Corp., a primary dealer, in a Nov. 22 telephone interview. “These are not numbers that are going to get down your unemployment rate,” which has held at or above 9 percent every month except two since May 2009, he said.

New Urgency

The company forecasts the Fed will buy $800 billion of securities, which may include Treasuries.io7Y1VKL13Uc

Efforts to bolster the economy are taking on new urgency with $1.2 trillion in automatic government spending cuts slated to begin in 2013. The Commerce Department said last week that gross domestic product expanded at a 2 percent annual rate in the third quarter, less than the 2.5 percent it originally projected, and Europe’s worsening debt crisis threatens to further curb global growth.

The Fed is taking the view that “even if U.S. fundamentals look to be relatively okay, we’ve got to keep our eye on any contagion from the European stresses,” Dominic Konstam, head of interest-rate strategy at primary dealer Deutsche Bank AG in New York, said in a Nov. 22 telephone interview. “It’s in that context that they’re willing to do more.”

Treasuries rose last week on those concerns, with the 10- year yield falling five basis points, or 0.05 percentage point, to 1.97 percent, according to Bloomberg Bond Trader prices. The rate rose six basis points to 2.03 percent today as of 8:52 a.m. in London. The 2 percent security due November 2021 fell 17/32, or $5.31 per $1,000 face amount, to 99 3/4.

Inflation Outlook

Policy makers have scope to print more money to buy bonds in a third round of quantitative easing, or QE, as the outlook for inflation eases.

A measure of traders’ inflation expectations that the Fed uses to help determine monetary policy ended last week at 2.25 percent, down from this year’s high 3.23 percent on Aug. 1. The so-called five-year, five-year forward break-even rate, which projects what the pace of consumer-price increases will be for the five-year period starting in 2016, is below the 2.83 percent average since August 2007, the start of the credit crisis.

iAsWAzZisdi4“There is a significant chance that QE3 will be deployed, especially in the form of MBS purchases, if inflation expectations fall enough,” Srini Ramaswamy and other debt strategists at JPMorgan in New York wrote in a Nov. 25 report.

Relative Growth

JPMorgan is one of the five dealers that don’t forecast the Fed will begin a third round of asset purchases to stimulate the economy. The others are UBS AG, Barclays Plc, Citigroup Inc. and Deutsche Bank.

After cutting its target interest rate for overnight loans between banks to a range of zero to 0.25 percent, the Fed bought about $1.7 trillion of government and mortgage debt during QE1 between December 2008 and March 2010, and purchased $600 billion of Treasuries between November 2010 and June through QE2.

The moves have helped. At 2.2 percent, U.S. GDP will expand more next year than any other Group of Seven nation except Japan, separate surveys of economists by Bloomberg show.

“Monetary policy is in part a confidence game,” said Chris Ahrens, head interest-rate strategist at UBS Securities LLC in Stamford, Connecticut. “At this point in time we don’t see the need for it, but if the situation were to evolve in a negative fashion they’re telling us they can come out and respond in a proactive fashion.”

‘Frustratingly Slow’

Minutes from the Nov. 1-2 meeting of the Fed’s Federal Open Market Committee showed some policy makers aren’t convinced the recovery will strengthen, saying the central bank should consider easing policy further.

“A few members indicated that they believed the economic outlook might warrant additional policy accommodation,” the Fed said in the minutes released Nov. 22 in Washington.

Bernanke, at a press conference after the meeting, said the “pace of progress is likely to be frustratingly slow,” while on Nov. 17 Fed Bank of New York President William C. Dudley said if the central bank opted to buy more bonds, “it might make sense” for much of those to consist of mortgage-backed securities to boost the housing market.

Mortgages were at the epicenter of the financial crisis that began in 2007 and resulted in more than $2 trillion in writedowns and losses at the world’s largest financial institutions based on data compiled by Bloomberg.

Sales of existing homes have averaged 4.97 million a month this year, little changed since 2008 and down from 6.52 million in 2007, according to the National Association of Realtors. The median price decreased to $162,500 in October from $170,600 a year earlier and from the record $230,300 in July 2006.

Housing Glut

At the current pace of sales it would take eight months to clear the inventory of available properties, compared with the average of 4.8 before 2007.

Fed purchases of mortgage bonds would dovetail with efforts by President Barack Obama, who has been promoting an initiative by the Federal Housing Finance Agency to let qualified homeowners refinance mortgages regardless of how much their houses have lost in value. The Home Affordable Refinance Program, or HARP, will eliminate some fees, trim others and waive some risk for lenders.

The difference between yields on Fannie Mae’s current- coupon 30-year fixed-rate securities, which influence loan rates, and 10-year Treasuries climbed to 121 basis points last week, from 84 basis points on Dec. 31, Bloomberg data show. The spread widened to 129 basis points in August, the most since March 2009.

‘Powerful Wildcard’

“The prospect of the Fed buying MBS under a QE3 program is a powerful wildcard, and should limit the downside in the asset class,” the JPMorgan strategists wrote in their report last week. “Given attractive spreads currently, we recommend heading into 2012 with an overweight,” they said in reference to a strategy where investors own a greater percentage of a security or asset class than is contained in benchmark indexes.

Mortgage securities guaranteed by government-supported Fannie Mae and Freddie Mac or federal agency Ginnie Mae have financed more than 90 percent of new home lending following the collapse of the non-agency market in 2007 and a retreat by banks. The agency mortgage-bond market accounts for $5.4 trillion of the $9.9 trillion in housing debt outstanding.

The Fed, which owns about $900 billion of the securities, said in September it will reinvest maturing housing debt into mortgage-backed bonds instead of Treasuries. MBS holdings represent about 40 percent of the Fed’s balance sheet, down from a peak of about 66 percent.

“If the Fed’s position in MBS grew under QE3 to half of its balance sheet, this would imply that they would have to purchase on the order of $500 billion,” the JPMorgan strategists wrote in their report. The Fed’s “decision to reinvest paydowns back into the mortgage market suggests a comfort level with owning mortgages that seems to have grown,” they wrote.

Primary Dealer Forecasts for Likelihood of Fed Bond Purchases


Firm                Fed Purchases    Amount       Timing


Bank of America      Mortgages#  $800 billion     Q2/Q3 2012

Bank of Nova Scotia  Treasuries  $600 billion     1st half 2012

Barclays                None

BMO Capital Markets  Mortgages       N/A          Q1 2012

BNP Paribas          Mortgages       N/A          April 2012

Cantor Fitzgerald    Mortgages   $750 billion     June 2012

Citigroup               None

Credit Suisse        Mort/Tsys       N/A          Q1 2012

Daiwa                Mort/Tsys   $250 billion     March 2012

Deutsche Bank           None

Goldman Sachs        Mortgages#      N/A          1st half 2012

HSBC                 Mortgages       N/A          Q1 2012

Jefferies            Mortgages   $500 billion     2nd half 2012

JPMorgan Chase          None

Mizuho               Mort/Tsys   $800 billion     1st half 2012

Morgan Stanley       Mortgages#  $100 billion     June/July 2012

Nomura               Mortgages   $400 billion     1st half 2012

RBC                  Mortgages   $750 billion     1st half 2012

RBS                  Mortgages   $600 billion     April 2012

Societe Generale     Mortgages   $500 billion     1st half 2012

UBS                     None

Average                          $545 billion




#May also include Treasury purchases

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