Big Fed buying tames the mortgage basis
admin | March 27, 2020
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
The Fed has taken dramatic action to support MBS markets struggling to deal with the economic effects of the coronavirus. The Fed started adding MBS on March 16 and vastly increased its purchases starting March 20. Earlier the Fed had allowed its MBS portfolio to pay down and only bought more than a small amount when amortization and prepayment exceeded $20 billion a month. The latest round of heavy buying has helped substantially calm the market, tightening the nominal basis by more than 100 bp and bringing it closer to typical levels.
The Fed on March 15 initially committed to buying at least $200 billion MBS over an unspecified timeframe. The central bank bought $17.4 billion MBS over the first three days of the following week, which proved insufficient to calm MBS markets. Purchases increased to $14.4 billion on March 19 and to $35.8 billion on March 20. On March 23, the Fed announced purchases of MBS in whatever quantities necessary to support smooth functioning of the market, and later signaled a target of $50 billion per day. However, purchases over recent sessions averaged roughly $35.5 billion per day (Exhibit 1).
Exhibit 1: The Fed has purchased $210 billion MBS in 9 days ($ mm)
Source: New York Fed, Amherst Pierpont Securities
The Fed has focused on buying 30-year UMBS but has also included a substantial amount of G2SF and FNCI contracts as well. More than 40% of the purchases were for April TBA with non-standard T+3 settlement. So far the Fed has only purchased April and May TBA contracts, with April accounting for 59% of all purchases.
The buying has had the intended effect. Prior to March, the basis was generally range bound between 80 bp and 100 bp but peaked at nearly 200 bp on March 19. The Fed’s massive buying program has lowered the basis to nearly 100 bp, just slightly above the pre-crisis range.
Exhibit 2: The mortgage basis tightened dramatically due to Fed buying this week
Source: Yield Book, Amherst Pierpont Securities
This amount of buying has erased a significant chunk of the quantitative easing undertaken by the Fed. The MBS portfolio was roughly $1.78 trillion in March 2018 and had fallen to roughly $1.37 trillion in March of 2020. The Fed has conducted this buying program at a record pace. The portfolio paid down $410 billion over the course of two years and half that amount has been re-purchased over the last nine days. The current pace also surpasses buying following the 2008 financial crisis—the Fed’s MBS portfolio posted its largest month of growth in February 2009, adding $167 billion in settled holdings as a result of a full month of purchase activity. The Fed looks set to blow through that number next month.
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