MBS Weekly Market Commentary Week Ending 3/18/22

This week was all about the Fed. Let’s look at the effect of quantitative easing on MBS spreads, updated economic projections from the FOMC, and how President Biden’s nominee, Sarah Bloom Raskin, is going to have a difficult time winning approval in Washington D.C.

 

As expected, the Federal Reserve raised interest rates this week for the first time since 2018. MBS and Treasuries were sold off in the aftermath of the announcement. One point of note is that the Federal Reserve’s unwinding of its bond buying program has been having a stronger impact on mortgage rates than Treasury yields.

 

The Fed’s re-introduction of quantitative easing (QE) back in 2020 in response to Covid pushed MBS spreads, or the difference between the yield on mortgage backed securities and Treasuries, down. Spreads had peaked at the onset of the pandemic during the period of margin calls and the Fed’s purchases of MBS helped mask some of the effect of increasing volatility in the bond market. 

 

Now that QE is over, MBS spreads are returning to normal, albeit wider than normal. During QE, long-term rates had a very low signal-to-noise ratio. The reduction in purchases of Treasuries and MBS has made the shape of the yield curve (the difference between longer-term rates and shorter term rates) once again transmit useful information. 

 

Mortgage rates have been rising easily when the 10-year yield increases. They are moving down stubbornly, if at all, when the 10-year yield falls. It is important to remember that this only represents what MBS investors are willing to pay for generic mortgage backed securities and doesn’t take into account competitive activity between mortgage bankers. 

 

When it came to the actual FOMC meeting, statement, “dot plot,” and press conference this week, the consensus is now that the Fed Funds rate will be between 1.75% and 2.25% by the end of the year. The Fed expects to have rates above the long-term expected rate for 2023 and 2024, though much of this will be determined by the path of inflation.

 

Economic forecasts were adjusted, with the 2022 GDP growth forecast cut to 2.8% from 4% and the inflation rate increased to 4.3% from 2.6% in December. The press conference contained no surprises, though Fed Chair Powell said the uncertain effects of the war in Ukraine were likely to push up inflation while slowing economic growth. 

 

It remains to be seen what will happen to prices when the Fed begins to unload its holdings of MBS. Even with refinance volume drying up, making for less supply from mortgage banks, Fed has a lot of paper that needs to go.

 

In Washington D.C., Sarah Bloom Raskin, Biden’s nominee, had a blow dealt to her nomination after West Virginia Senator Joe Manchin expressed opposition to her nomination. Manchin’s issue with Raskin is that she wanted the Fed to take climate into account in banking regulation which would restrict credit to the energy industry. His concern is that the Fed could decide that excessive energy exposure would cause a bank to flunk its stress test, which would then limit dividends and buybacks. Without Manchin’s support, she will need a Republican to vote for her, an unlikely scenario.