Mortgage-Bond Spreads Cap Biggest Weekly Drop Since December ’08

A measure of relative yields on mortgage securities that guide U.S. home-loan rates capped its biggest weekly drop in almost four years on speculation that the Federal Reserve will find a shortage of the bonds as it expands purchases.

A Bloomberg index of yields on Fannie Mae-guaranteed mortgage bonds trading closest to face value fell about 7 basis points, or 0.07 percentage point, today to a record low 61 basis points higher than an average of five- and 10-year Treasury rates as of 5 p.m. in New York.

This week’s drop of 34 basis points, the largest since December 2008, exceeds the decline of 19 in the final two days of last week after the Fed’s Sept. 13 announcement that it would expand its balance sheet with monthly purchases of $40 billion of government-backed housing debt until the economic recovery strengthens.

“It’s been a truly extraordinary seven days,” said Scott Simon, the mortgage head at Newport Beach, California-based Pacific Investment Management Co., manager of the world’s largest bond fund. The $273 billion Pimco Total Return Fund (PTTRX) has used outsized bets on home-loan securities to beat 97 percent of its peers this year, gaining 8.8 percent, according to data compiled by Bloomberg.

Bond-Buying

The Fed’s mortgage-bond buying will probably total between $65 billion to $75 billion a month, including a previous program of reinvesting proceeds from repayments on its past purchases, Nomura Securities International analysts said in a report today. That compares with about $96 billion of issuance a month of securities that aren’t set aside by lenders to be sold for higher prices because they can offer more protection against homeowner refinancing, the analysts said.

The securities that the central bank will probably focus on “had a great run over the past two weeks,” outperforming baskets of Treasuries with similar durations by between 1.5 cents and 2 cents on the dollar, Nomura analysts led byOhmsatya Ravi wrote in the report.

Home buyers and owners looking to refinance aren’t receiving benefits from the Fed’s action equal to the size of its effect in financial markets, as banks overwhelmed by a jump in applications earlier this year limit how much they reduce borrowing costs to avoid more demand.

Mortgage Rates

The average rate for a 30-year fixed mortgage fell to 3.49 percent in the week ended yesterday, matching the record low set during the week of July 26, according to Freddie Mac. Absolute yields on the so-called current coupon Fannie Mae mortgage securities have fallen to 1.82 percent, from a low of 2.19 percent during that week of July.

The New York-based Nomura analysts said that the debt’s spreads may widen in the short-term amid sales as investors book gains from profitable trades. A long-term risk is that the Fed may change the assets bought under its so-called quantitative easing program, they said.

“As MBS spreads continue to tighten, there will be a point at which the Fed might deem distortions in the MBS market to be unacceptable and use other asset classes,” specifically Treasuries, they wrote.

In a sign that the Fed’s buying may be straining the market, during the week ended Sept. 19 the central bank entered into contracts to sell $1.4 billion of mortgage-backed securities in October, essentially canceling and pushing out previous purchases, according to data released yesterday. The central bank’s net purchase contracts totaled $17.5 billion during the week.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

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