Fed MBS purchase program seen extending into 2010
NEW YORK (Reuters) - The U.S. Federal Reserve will likely extend the timeframe of its program to buy $1.25 trillion of agency mortgage backed securities (MBS) to give the market more time adjust to the loss of the central bank's buying power, analysts said.
Earlier this year the U.S. Federal Reserve set a goal of buying up to $1.25 trillion of agency MBS, $300 billion of Treasuries, and $200 billion of agency debt in 2009 to help lower borrowing costs for home owners.
The Fed purchases of agency MBS total $741.608 billion so far in 2009.
At this month's Federal Reserve monetary policy meeting, the Fed decided to gradually phase out the much-smaller $300 billion U.S. Treasuries purchase program by October, postponing the end of the plan by a month.
The Fed's purchases have helped lower mortgage rates, making homes more affordable amid the worst housing slump since the Great Depression.
But without the Fed's buying the housing market's recent stabilization might not continue, analysts said.
"We think this gradual transition away from Treasury purchases is likely the method they'll employ for the other purchase programs," said Tom Porcelli, U.S. economist at RBC Capital Markets in New York.
The Fed's departure from the U.S. Treasuries market may be less tricky than the wind down of its purchase program in the roughly $5 trillion market for mortgage backed securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae.
But extending the time line, while maintaining the current size of the program, would enable a smoother transition, said Brett Rose, director of agency MBS strategy at Citigroup in New York.
"This will allow 'real' market liquidity to gradually return with minimal disruption to current spread levels," he said.
The Fed will likely extend its agency MBS purchase program into the first three months of 2010, he said.
Indeed, Federal Reserve agency MBS purchases have already slowed down. After purchasing roughly $25 billion per week earlier this year, it hovered around $20 billion in July and August.
The slowdown in the pace might indicate that a transition has already begun and, at the current pace, the program will not hit its target until late January or early February, Goldman Sachs said in recent research.
Using its own calculations and Federal Reserve data as of the week ending August 5, Goldman Sachs said the implied end date at the current pace of purchases would be January 31, 2010.
But, agency MBS prices have remained expensive despite the recent slowdown in the pace of purchases.
Agency MBS spreads have tightened about 80 basis points versus swaps and 110 basis points versus Treasuries from the announcement of the Fed's agency MBS purchase program, said Janaki Rao, vice president of mortgage research at Morgan Stanley in New York.
The initial 50 basis points outperformance versus swaps was clearly due to the Fed's entry into the market, while subsequent improvement in financial markets and risk appetite explains the remaining 30 basis points, he said.
Morgan Stanley's Rao said a slow exit of the Fed should cause mortgages to possibly widen versus swaps by approximately 15-20 basis points, and by a somewhat similar amount versus Treasuries, but perhaps 5-10 basis points more.
"There is money on the sidelines waiting to invest in mortgages once clarity is achieved on Fed's exit strategy," he said.
The Fed's program was seen as integral to lifting the economy from the depths of recession earlier this year and it helped push 30-year home loan rates to a record low of 4.78 percent recorded by Freddie Mac in April. Mortgage rates, however, have since risen, reaching 5.29 percent in the week ending August 13.
Prior to 2009, the Federal Reserve had never purchased agency MBS, so its presence in this market has been significant, with the Fed now owning about 15 percent of the market, according to Mukul Chhabra, associate in the mortgage strategy group at Credit Suisse in New York.
Fannie Mae and Freddie Mac combined own roughly 17 percent of the market, while commercial banks own around 20 percent, he said.
Credit Suisse is projecting a $1.5 trillion gross issuance for 2009 assuming that current rate levels are sustained for the rest of the year. Year-to-date the market has seen roughly $1 trillion gross issuance, which implies another $500 billion for the remainder of 2009.
The Fed's purchases as a share of gross issuance have ranged around 60 percent for the last two months, Chhabra said.
"Given that there is still $510 billion of unused commitment, a pace of $15 billion purchases a week could extend the program through end of April 2010," he said.
"This should allow a gradual transfer to private investors and yet keep mortgage rates around current levels for longer," he said.
(Additional reporting by Kristina Cooke)
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