Fed’s latest taper plan likely to be more orderly than ‘13-’14’s

The Federal Reserve’s exit from its mortgage-backed securities purchase program should be more orderly than during the 2013-2014 period, which had caused a “taper tantrum” by investors, a Keefe, Bruyette & Woods report said.

MBS nominal and option adjusted spreads both widened by 1 basis point following the Fed’s Wednesday announcement, after increases of 5 bps and 4 bps earlier in the week. But they are still below historical averages, said KBW’s Bose George.

“However, we think that further spread widening is inevitable as the 800-pound gorilla reduces its presence in the Agency MBS market,” George said. “We continue to believe that further (but modest) widening is the path of least resistance.”

The majority of the Fed’s MBS portfolio is at a coupon equal to or below 3%, according to George’s estimates.

“With mortgage rates currently at around 2.9%, the refi risk in the Fed’s current portfolio is low, so the run-off period should also be very gradual,” he postulated. “It remains unclear if the Fed will sell MBS at some point but if that happened we would expect that to be very methodical as well.”

The benchmark 10-year Treasury yield was 1.4%, up 6 bps, by noon on Thursday from its previous close. While the yield broke above 1.4% for the first time since July 13, this is still lower than the 177 bp 52-week peak reached on March 31.

The Mortgage Bankers Association’s latest forecast, which came out on Tuesday, has mortgage rates hitting 4% by the end of 2022. Its most recent Weekly Application Survey has the 30-year conforming fixed rate mortgage at 3.03% for the fourth week in a row. Meanwhile the 10-year yield will rise to 2.3% in the fourth quarter of 2022 from 1.3% for the third quarter of 2021.

Given the current rate of job growth and inflation in addition to ongoing supply chain issues, it is not surprising that the Fed would pull back, MBA Chief Economist Mike Fratantoni said in a statement issued after the Fed announcement. Though he expects mortgage rates to rise in the “medium term,” low inventory remains the greatest hindrance to home sales.

“The biggest challenge to the housing market continues to be the lack of supply, hindered by the same supply chain constraints that are impacting the broader economy,” he said.

His latest forecast calls for $3.7 trillion of volume in 2021, with $2.34 trillion next year and $2.47 trillion the following year. But purchases will make $1.6 trillion this year, $1.73 trillion in 2022 and $1.83 trillion in 2023.

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