Mortgage Rates Back on the Rise
After spending eight weeks receding from a multi-year high in June, mortgage rates are back on the rise. With yesterday’s selloff, the 30-year mortgage rose to 6.23 percent according to Mortgage News Daily. That places it just shy of this year’s high of 6.28 percent from mid-June.
Why? Fed Chair Powell has clearly communicated his vow to step up the fight against elevated inflation, even though it means pain for the economy. The markets seemed to be shrugging off that type of “Fed speak” until he increased his hawkish tone in remarks at Jackson Hole, Wyoming last week. It bears repeating that monetary policy acts with about a 6-9 month lag, so the large Fed rate increases over the past few months have yet to impact the economy.
Fed Plans to Reduce Balance Sheet
In addition to raising the overnight Fed funds rate, the Fed is exiting the MBS and security purchase space as it wraps up QE4. Since January of 2020, the Fed’s balance sheet has grown more than 93% to $2.7 trillion. The Fed will reduce its asset holdings by not reinvesting the funds received from maturing securities into new securities as it has been doing over the past two years. Instead, it will redeem the maturing security, which will reduce the size of its balance sheet. It is also assumed that the current Fed purchase schedule is the last schedule before ceasing the central bank’s direct purchase of MBS.
Since January of 2020, the Fed’s balance sheet has grown more than 93% to $2.7 trillion.
QE4 was by far the most aggressive and largest of all the QE programs, helping spark both record levels of agency mortgage bond issuance and a home price boom. This latest QE program saw total gross purchases of agency MBS at just under $3.1 trillion, larger than both QE1 and QE3 combined (a cumulative $2.8 trillion gross in aggregate). The central bank has essentially monetized 75% of all growth seen in the agency MBS market over that time period. Aggregate agency mortgage bond debt outstanding now stands at about $8.5 trillion, a 26.3% increase since January 2020. This will be the Fed’s third attempt at trying to get MBS off its balance sheet, though active MBS sales are not seen as a material risk at this time.
The Fed wants a predictable and smooth reduction in its balance sheet, so instead of sales, it has imposed redemption caps on the dollar amount of securities that will run off in any given month. For Treasuries, this monthly cap currently sits at $60 billion; for agency MBS, the monthly cap is $35 billion. The additional MBS supply the central bank will allow to roll off from its portfolio and hit the market this month is estimated between $20 and $25 billion, and will need to be taken down without the Fed’s QE training wheels. This will necessitate private investors to absorb about $250 billion in additional supply per year over the next decade. Mortgage spreads widened toward the end of August as a result of investors beginning to take the Fed seriously.
Should the Fed decide to speed up the process and begin to actively sell mortgages off its balance sheet (again, not likely), it will be the production coupons from the past few years that will bear the brunt of it: UMBS 30-year 2% and 2.5%, Ginnie Mae 30-year 2%, and UMBS 15-year 1.5% and 2%. When it comes to new agency mortgage bond issuance, UMBS 30-year 6% has been in production and we are seeing issuance growth in that coupon, and other higher note rate coupons, which is expected to continue.
The Fed is at least scaling back at an opportune time. August gross issuance of all agency mortgage bonds came to $128.7 billion, 46% of this time in 2021, the lowest since June 2019, and the fifth monthly decline in a row. Gross issuance year-to-date now stands at $1.3 trillion and is expected to end the year at around $2 trillion. While this would be above the $1.3 trillion annual average seen during the 2000 through 2019 period, it would also be far below the $3.3 trillion average seen in 2020 and 2021. While that party is likely over, hopefully, you have a party or something fun planned for a great Labor Day weekend.
Unemployment Slightly Raised
Today’s jobs report, in which the unemployment rate ticked up to 3.5%, can almost be viewed as a reversion to the old “bad news is good news” phenomenon. We saw a rally in the wake of the report, with the interpretation being that the Fed’s tightening is gaining traction. The labor force participation rate increased to 61.4% from 61.1%, so this uptick in unemployment was driven by both an increase in the unemployed and an increase in the labor force. Bond markets have breathed a sigh of relief at the potential the Fed may reconsider its hawkish stance.
See you next week.
