Details on Fed Balance Sheet Reduction

2018-01-02T18:42:08+00:00 June 15th, 2017|Categories: Uncategorized|Tags: , , , , , |

After its meeting concluded on June 14th, the Fed provided some details about the plan to reduce its holdings of U.S. Treasuries and agency debt and mortgage-backed securities (MBS). Regarding the starting time for the reductions, Fed Chair Yellen said that they could begin “relatively soon if the economy performs in line with the Fed’s forecasts. This comment caused investors to anticipate that the starting time will be in September or October, which was sooner than expected. In a document called the Policy Normalization Principle and Plans, the Fed laid out additional information. They will reduce their holdings by not reinvesting all the principle payments received. Over the last few years, they have held the level of their holdings steady by reinvesting all the principle payments received. The amount of principle payment received that will not be reinvested will start at $10 billion per month and will grow by $10 billion every three months until the monthly total reaches $50 billion. The reduction then will be capped at $50 billion and will continue until the size of the Fed’s holdings has fallen to the desired level. The Fed did not disclose the desired level but did say they expect the [...]

Fed’s Plan for Balance Sheet

2018-01-02T18:46:34+00:00 May 25th, 2017|Categories: Uncategorized|Tags: , , , , , , , |

During the quantitative easing years of 2008 through 2014, the Fed acquired trillions of dollars of Fannie Mae, Freddie Mac and Ginnie Mae mortgage-backed securities (Agency MBS) and U.S. Treasuries. Its balance sheet grew from under $1 trillion to over $4 trillion. The Fed stopped adding to its holdings a few years ago, but has maintained a policy to reinvest principle payments received, thus maintaining a steady level of investments. At times over the last few years when refinance activity was high and the Fed was reinvesting the principle payments it received, the Fed was the buyer of the vast majority of all newly issued Agency MBS. Even recently, the Fed has been the buyer of approximately 25% of newly issued Agency MBS. The demand from the Fed for Agency MBS has had a positive effect on mortgage rates. For the past few months, Fed speakers have been saying that the time to begin “normalizing their holdings was near. But few details were provided.  The minutes of the Fed’s May 3nd meeting, released on May 24th, provided some details about their plan. Although many details remain unknown. The plan calls for the Fed to tell investors the maximum amount it [...]

French Presidential Election

2017-12-20T17:34:11+00:00 April 20th, 2017|Categories: Uncategorized|Tags: , , , , , |

The first round of the French Presidential election will take place on Sunday. It is significant for global markets because of its potential implications for the future of the European Union (EU). The two candidates who receive the most votes on Sunday will proceed to the second round of voting on May 7, and the latest polls show that the top four candidates are very close. Two of these four (Le Pen and Melenchon) favor exiting the EU. The possibility that an anti-EU candidate could win has caused investors to shift to safer assets, which has helped mortgage rates in recent weeks. A strong showing by the anti-EU candidates would be good for mortgage rates, as investors likely will shift additional funds into safer assets. If they do poorly, it is expected that investors would shift back into riskier assets, which would be negative for rates.

Trump Trade Reverses

2018-01-02T18:42:32+00:00 March 28th, 2017|Categories: Uncategorized|Tags: , , , , , |

Since the election, stocks have performed very well, while bonds yields have risen. This was due to expected policy changes under the Trump administration which would boost economic growth. Stronger growth is good for the economy and for stocks, but it raises the outlook for future inflation, which is negative for mortgage rates. Over the past week, President Trump encountered resistance to a health care bill. This increased investor concerns about the ease with which Trump will be able to deliver his pro-growth policy changes in areas such as tax cuts, deregulation, and infrastructure spending. As investors questioned whether the policies might be smaller in scale or might take longer to implement, some of the "Trump Trade" reversed this week, which was good for mortgage rates.

European Elections

2018-01-02T18:45:57+00:00 February 24th, 2017|Categories: In The News|Tags: , , , , , , |

One source of volatility for MBS prices is uncertainty about the outcome of upcoming elections in several European countries. Investors are most focused on the presidential election in France which will take place on April 23. Polls show a close race between Marine Le Pen and Emmanuel Macron. Le Pen's campaign has been centered on plans for France to leave the European Union (EU) and to stop using the euro currency, while the centrist Macron has run on a more traditional platform. It is not clear what would happen to the EU if France decided to exit. As a result, investors have reacted by shifting to safer assets after news which favors a Le Pen victory and doing the opposite after positive news for Macron. Since U.S. MBS are viewed as relatively safer assets, they have been affected by the shifts in sentiment, causing volatility.

Yellen Testimony

2018-01-02T18:43:30+00:00 February 14th, 2017|Categories: In The News, Special Update|Tags: , , , , , |

In her semi-annual testimony to Congress, Fed Chair Yellen said that the Fed expects that economic progress will call for "further gradual increases" in the federal funds rate. She also said that it would be "unwise" to wait too long to hike rates. Yellen later added that the Fed will consider in coming months when to begin to reduce the Fed's holdings of MBS. Of note, she said that the Fed will not sell MBS to shrink the holdings, but rather will stop replacing principal reductions. The expected pace of tightening by the Fed increased a little after her testimony, causing MBS to decline.

Effect of Tax Cuts

2018-01-02T18:44:04+00:00 February 9th, 2017|Categories: In The News|Tags: , , , , , , |

President Trump today said to expect an announcement about tax cuts in two to three weeks. Mortgage rates moved a little higher after the comment. There are two reasons why tax cuts are viewed as negative for mortgage rates. The first is that tax cuts increase the wealth of the affected individuals or businesses, leaving them with more money to spend. This added spending boosts economic activity, which increases the outlook for future inflation. Mortgage rates rise as expected future inflation rises, since higher inflation further erodes the value of a mortgage’s future cash flows. The second is that tax cuts increase the budget deficit, at least initially. This means that the government has to issue more Treasury bonds to fund the deficit. The added supply reduces the value of Treasuries and similar bonds, including mortgage-backed securities (MBS). A decline in MBS prices leads to higher mortgage rates.

Fed Meeting

2018-01-02T18:44:35+00:00 December 14th, 2016|Categories: Special Update|Tags: , , , , , |

As widely expected, the Fed raised the federal funds rate by 25 basis points. Unfortunately for MBS, Fed officials also raised their outlook for the pace of future rate hikes. They now forecast three rate hikes in 2017, one more than previously projected. The faster pace was viewed as negative for mortgage rates. But why? The purpose for raising the federal funds rate is to keep inflation from rising above the Fed's target of 2%. This should be a good thing for mortgage rates. Part of the reason for the adverse reaction stems from a more direct effect the Fed has on mortgage rates. The Fed owns over $1.7 trillion of the agency mortgage-backed securities (MBS) that it purchased during its quantitative easing (QE) days. The Fed keeps the balance of MBS around that level by buying new MBS to replace that which pays off. The Fed is currently the buyer of approximately 25% of all newly issued MBS. This added demand from the Fed drives MBS prices higher and mortgage rates lower. The Fed says that it will not allow its holdings of MBS to decline until "normalization of the level of the federal funds rate is well under [...]

Italian Referendum

2018-01-02T18:45:42+00:00 November 28th, 2016|Categories: In The News|Tags: , , , , , |

 Next Sunday, voters in Italy will decide on a referendum presented by Prime Minister Matteo Renzi which would reform the constitution to speed up lawmaking and to produce a more stable government. If the referendum fails to pass, there is the potential for many troubles to develop in Italy. First, much needed reforms for the Italian banking sector likely would be postponed, which would put many banks at risk of failing. Investors are concerned that this could impact banks throughout Europe. In addition, Renzi has said that he will step down if the referendum does not pass. His resignation would likely lead to a period of political uncertainty in Italy, and it could result in more power for a political group which favors leaving the euro. In the wake of the Brexit vote in the UK, investors would be very concerned if they saw the potential for Italy to exit the European Union. The most recent polls show that it may be a very close vote. Investors have reacted to the uncertainty by shifting to safer assets, including U.S. mortgage-backed securities (MBS). Since mortgage rates are set based on MBS prices, the news resulted in improvement. For the rest of [...]

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