Is there more widening ahead for mortgages? The Fannie Mae 30-year current coupon spread went from +180 BPS in March 2020 to +60 BPS in April 2021, and now sits around +130 BPS. A lot of the widening potential depends on the Fed’s balance sheet, which now totals about $2.7 trillion of agency MBS. The coupons the Fed holds the most of are those that were produced over the past two years: G2SF 2% and 2.5%, UMBS30 2% and 2.5%, and the UMBS15 1.5% and 2%.
After flooding the housing sector with deluge of cheap credit since March 2020, the U.S. central bank is now looking to stem the tide. Daily Fed purchases of agency MBS are now well under $1 billion a day on the latest purchase schedule, a far cry from the record $41 billion purchased on March 27, 2020, and $36.6 billion daily average that month when the central bank ramped up QE4. 2021 saw the central bank take down an average of $5.3 billion per day in agency MBS. The 30-day trailing average of daily purchases is now at $1.3 billion, down from its high of $19 billion seen in April 2020.
The New York Fed’s latest agency mortgage bond purchase schedule takes us one step closer to the central bank allowing mortgages to simply roll off its holdings. Prepayment speeds have gone from a torrent to a trickle as most American homeowners have no refinance incentive. As a result, the runoff from the Fed’s balance sheet is not likely to hit the $35 billion per month cap that will come into effect in September – it is likely to be about $25 billion in roll off per month over the near term – meaning the roll off from the Fed’s balance sheet over the second half of this year should add another $150 to $180 billion in mortgage bond supply.
While any Fed sales of mortgages likely won’t occur until 2023, at the earliest, should the central bank engage in active selling (and that remains undetermined), those coupons mentioned in the opening paragraph are likely to see the most spread widening as a result. This will be the Fed’s third attempt to get back to an all-Treasury balance sheet and another question is how eager will money managers be to take down supply at these spreads? The recent elevated volatility has kept banks on the sidelines.
The FNMA 30-year current coupon spread over the blend of 5-year and 10-year Treasury yields is currently over two standard deviations above its trailing half-decade average. Volatility has re-entered the picture. The problem with inflation remains and slowing money supply growth will further dampen the securities market. More Fed rate hikes are coming through year-end. Year-end forecasts for the Federal Reserve rate hikes increased to 3.50% from 2.75% one month earlier.
While it is a tough time for the mortgage industry, did you really think QE4 was going to end any differently? It was always unlikely that the Fed could pour over $3 trillion of buying power into the mortgage sector and then turn off the spigot without markets reacting adversely. Now that the Fed has removed the training wheels off agency MBS, liquidity needs to develop in higher coupons so that we have better par rates, which will ease pricing issues. Lenders also must focus on cost reduction.
Caution is warranted. Looking for more tips on how to navigate this period of increased volatility? Hopefully you attended our webinar on Improving Profitability to Counter Market Headwinds. We have also had several client-specific webinars over the last few weeks. Contact us if you are looking for a better suite of secondary marketing products or more guidance on how to manage market volatility.
