Rate Watch: Fed MBS Purchase Program Virtually Over
A: Time to keep our eyes on the Mortgage Markets to see what the initial reactions might be as the Fed marks the end of the The Great Debt Monetization Experiment of 2009/2010. With only $2bln of newly printed electronic dollars left to purchase Agency Backed Mortgage Backed Securities (MBS), next week will be the first time in a long time where the Fed will not be supporting these markets via direct purchases. We should watch the mortgage markets and treasury markets for any re-alignment as we enter a new phase in the Fed's exit strategy.
Via Calculated Risk, "Countdown: Fed MBS Purchase Program only $2 Billion more:
So the program is essentially over. We should be watching to see if 10 Year Treasury yields rise - and if mortgages take "a beating".Chart below courtesy of Calculated Risk showing us the cumulative weekly totals (in Billions) of the Fed Agency MBS Purchases since January of 2009:
The Quantitative Easing (QE) policy was the most aggressive stage of Fed policy taken on to stem a severe credit crisis and strong deflationary headwinds. When rates are lowered to as low as they can go, this is the next step but is typically only used in extreme situations. Needless to say, what we went through was an extreme situation. In essence, the NY Fed purchases assets directly from Primary Dealers & Money Center Banks via Permanent Open Market Operations (POMO) using funds electronically created out of thin air; also known as 'printing money'.
To see this in black & white simply go to the NY Fed's "FAQs: MBS Purchase Program":
How are purchases under the agency MBS program financed?This new money is then deposited into the asset seller's excess reserves, explaining why we have seen such a huge rise in excess reserves held; (View image of Excess Reserves). In addition, the Fed is sterilizing the opportunity cost of using these excess reserves by paying interest for the first time in its history; a little piece of the puzzle put into place in October 2008 - a perfect setup for what was to come; the hoarding of money in excess reserves as the banks attempt to recapitalize. For those interested, read this primer on 'Why Are Banks Holding So Many Excess Reserves'.
Purchases will be financed through the creation of additional bank reserves.
The whole process is unprecedented in our history and we will not know the true unintended consequences of such policy actions taken to stem the crisis for years. What goes in will eventually come out and at some point in our future policy will be reversed to drain excess reserves. The fed is now setting up the platform for their exit strategy and conducting tests to see how markets might react in an attempt to minimize shocks to the system. But time is the only true test and next week will be the first glimpse into how the mortgage markets react to the fact that the fed purchases will soon be over. If I was waiting to lock in a rate, I'd probably do so sooner rather than later just in case.