The Big Q: How low can the 30-year mortgage rate go?
That is a concern investors have, as effective yields for MBS in some cases have already gone negative.
Mortgage investors can take heart knowing the Federal considers agency MBS a primary arena through which to conduct monetary policy.
It has purchased agency mortgage bonds at a record pace totaling $719-B just over $12-B a day on average, that according to data from the New York Fed. While the amount of buying over such a short frame has been surprising, the banks re-entry into the MBS market was not.
The Fed has used its power to stabilize markets and inject confidence. They drew a line in the sand and said they are going to support the larger part of the housing finance market, which is agency MBS.
Since the central bank’s 1st foray into mortgage purchases in late Y 2008, its opinion that doing so is proper “to support the mortgage and housing markets and to foster improved conditions in financial markets more generally” is little challenged.
On a practical level, the highly liquid agency MBS market, with its forward settlement of trades, allows for massive injections of Fed credit more readily than other sectors.
Judging by the Fed’s history, their holdings may grow. The recent buying increased the bank’s ownership to about 24% of the market’s total outstanding debt. From Ys 2016 through 2018 that average was about 28%.
The massive Fed credit is providing a boost for mortgage bond investors, and has brought about a reversal in the sector’s supply-demand equation. Forecasts saw $490-B more in supply needing to be absorbed by private investors this year, but after taking into account Fed buying, they may see available supply actually decline by $500-B, according to JPMorgan Chase & Co.
MBS Index excess return versus Treasuries has rallied 1.73% since QE’s restart on 16 March. The UMBS 30-year 2.5% coupon, the Fed’s main focus and where over 25% of its buying has occurred rallied 2.59%.
Lower coupon prices have surged, with the 30-yr UMBS 2%, 2.5% and 3% all increasing by at least three points over the same frame. And as home lending rates are set in the mortgage market the Freddie Mac 30-yr mortgage rate dropped to a record low 3.15% on 28 May from a local high of 3.65% on 19 March. Lower lending rates have increased concern about that bane of mortgage investors, prepayment speeds.
A Key feature of MBS’ (mortgage-backed securities) is that the underlying home loans may be prepaid by borrowers at par at any time. With almost the entire MBS universe changing hands at a premium, getting back funds faster than expected can hurt performance. The last 3 prepayment speed reports have come in above expectations.
We do not see the Fed as an outright seller in any reasonable scenario, “The Fed is here to stay.”
Have a healthy day, Keep the Faith!