Goodbye, Federal Reserve. Hello Fannie and Freddie.
With the Federal Reserve ending its 15-month $1.25 trillion mortgage bond buying binge on Wednesday, delinquent loan buyouts by Fannie Mae and Freddie Mac could serve as the saving grace for the $5 trillion agency mortgage-backed securities market.
The paydowns from these buyouts will put billions into the hands of mortgage investors for reinvestment and significantly reduce supply, mitigating the massive void the central bank will leave behind and helping keep yield spreads near record tights.
That is good news for the U.S. housing market since it should keep mortgage rates, which are linked to yields on Treasuries and yields on mortgage-backed securities, at historically low levels.
The timing is everything as the housing market enters its most important period -- the spring selling season -- and struggles to regain its old self as data shows growth has been anything but resurgent.
The delinquent loan buyouts of $200 billion by Fannie Mae and Freddie Mac, first announced in February, will put about $140 billion of cash into private investors' hands, according to Matthew Jozoff, managing director and head of mortgage strategy at JPMorgan in New York.
At the same time, these buyouts will remove about $200 billion of net supply from the market, his team said.
This 'double-whammy' is powerful, and effectively extends the Fed involvement several months from their official end date, they said.
LESS SUPPLY, LOW RATES
The Federal Reserve has plowed billions per week into the agency MBS market since early 2009 in an effort to bring down mortgage rates and to stimulate the battered housing sector and the overall economy.
The (Fannie and Freddie) buyouts should help take supply out of the marketplace, so in our view, the technicals have lined up to make the Fed exit go smoother than otherwise would have been expected, said Joe Ramos, lead portfolio manager on the U.S. fixed income team at Lazard Asset Management in New York.
While reinvestments from paydowns will not be big enough to fully offset the buying by the Fed, it should help keep prices firm, he said.
Mortgage rates play a crucial role in housing affordability. February home sales data points to a sector that has hit a lull after showing signs of a recovery late last year. New home sales fell for a fourth straight month, reaching a record low, while existing home sales fell for a third straight month.
Interest rates on 30-year fixed-rate mortgages, currently around 5 percent, will probably drift higher throughout 2010, ending the year at over 5.5 percent, according to Mark Zandi, chief economist at Moody's Economy.com, in West Chester, Pennsylvania.
The current 5 percent fixed rate has been key to keeping the housing market together as well as it has been kept together, he said. That the housing market is so weak despite the low rates suggests how strong the headwinds are to the housing market, including the tough job market, tougher underwriting standards, and the ongoing foreclosure crisis.
Mortgage rates will likely be buffered over the next few months as the majority of the paydowns get reinvested, but investors will also likely keep some cash as well, according to Janaki Rao, vice president of mortgage research at Morgan Stanley in New York.
The initial reaction to the buyout news indicated a rush toward the lower coupons as investors rushed to safeguard against faster prepays, he said.
While reinvestments are certainly a strong positive for agency MBS, a confluence of other factors should keep agency MBS firm as well. A buildup of cash, solid deposits and weak loan growth should foster strong bank demand for agency MBS going forward.
Furthermore, many money managers who were underweighted the sector for much of the past year amid lofty valuations are expected to buy on even modest cheapening. That, coupled with low supply, will offset the Federal Reserve's absence from the agency MBS market.
We do not see things changing in a major way, perhaps 10 to 20 basis points of widening without demand from the Fed, Lazard's Ramos said.
Demand from asset managers will likely have the largest impact on prices after the Fed exit, he said.
(Reporting by Julie Haviv; Editing by Jan Paschal)