Demand for the Federal Reserve’s sales of mortgage debt assumed in the 2008 government bailout of American International Group Inc. may add to reasons the central bank won’t soon expand its balance sheet again, according to Bank of America Corp.
The auctions of collateralized debt obligations held in the New York Fed’s Maiden Lane III portfolio are showing credit markets are relatively healthy, according to Bank of America analysts Chris Flanagan and Justin Borst. Securitized debt is better weathering the “risk-off” sentiment as Europe’s deepening debt crisis damages some assets, because of its shrinking supply and high yields, they said.
“The Fed’s recent direct, extremely positive experience in the credit market with its Maiden Lane III sales give it firsthand information that credit markets are in very good shape,” the New York-based analysts wrote in a May 11 report.
Seeing that strength, the Fed probably won’t rush to start a third round of debt purchases that increase its balance sheet, known as quantitative easing, or QE, the analysts said. Bank of America’s view is that the central bank’s policy makers will announce QE3 at their Sept. 12 meeting, even while “the recent weakening of the economic data and the heightened noise out of Europe are pushing up the likelihood of a July 31 announcement.”
About 52 percent of investors in government-backed mortgage bonds, which may be the focus of additional Fed debt buying, expect QE3 within the next six months, according to a survey in the first week of this month by JPMorgan Chase & Co. analysts.
Profit for Taxpayers
The New York Fed announced on May 11 it would sell $1.7 billion of CDOs tied to residential debt from Maiden Lane III in an auction ending May 17 and $691 million in a May 22 sale.
The central bank sold $2.5 billion of CDOs tied to home loans to Bank of America last week, following a successful auction last month of $7.5 billion of commercial-mortgage CDOs. It had disposed of $19.2 billion of home-loan securities in January and February, helping unwind its separate Maiden Lane II vehicle at a profit of $2.8 billion for taxpayers.
“For securitized products, the QE3 horizon is probably so far out that near term trading and investment decisions are best made assuming QE3 is not happening anytime soon, or not at all,” Flanagan and Borst wrote.
To contact the reporter on this story: Jody Shenn in New York at firstname.lastname@example.org.