Mortgage-Bond Spreads Fall to Five-Year Low on Bets Fed Will Buy

A measure of relative yields on Fannie Mae and Freddie Mac mortgage securities that guide home-loan rates tumbled to the lowest in five years after a report showed U.S. payrolls rose less than projected in August, raising the odds of a new round of bond buying by the Federal Reserve.

A Bloomberg index of yields on Fannie Mae-guaranteed mortgage bonds trading closest to face value fell about 7 basis points to 114 basis points, or 1.14 percentage points, higher than an average of five- and 10-year Treasury rates as of 5 p.m. in New York. That’s the narrowest spread since April 2007.

Lower-than-forecast U.S. employment growth will move the U.S. central bank closer to more so-called quantitative easing, Pacific Investment Management Co.’s Bill Gross said in a radio interview today on “Bloomberg Surveillance” with Tom Keene and Ken Prewitt. The Fed will probably extend its pledge to keep borrowing rates close to zero into 2015, and follow up with purchases of more Treasuries and mortgage securities, he said.

“If there was any lingering doubt within the Fed about announcing a new round of QE next week, this should surely push them over the edge,” Tom Porcelli, chief U.S. economist at RBC Capital Markets LLC in New York, said in a note to clients.

The economy added 96,000 workers last month following a revised 141,000 gain in July that was smaller than initially estimated, Labor Department figures showed today in Washington. The median estimate of 92 economists surveyed by Bloomberg called for a gain of 130,000.

‘Strong Hints’

Fed policy makers will give “strong hints” or provide “positive action” at next week’s rate-setting meeting, Pimco’s Gross said after the jobs report. The mortgage holdings of his $270 billion Total Return Fund, the world’s biggest bond fund, rose to 51 percent last month, from 25 percent in July 2011, according to data on the company’s website.

The central bank will probably buy $500 billion to $600 billion of government-backed mortgage bonds over 12 to 15 months under the program, according to Credit Suisse Group AG analysts led by Mahesh Swaminathan.

The analysts saw the purchases as almost inevitable after Chairman Ben S. Bernanke in an Aug. 31 speech signaled the Fed’s readiness to acquire more debt to bolster the economy. The analysts wrote in a report yesterday that “a decision of this magnitude is unlikely to be shaped by one last minute datapoint, barring an extraordinarily strong number.”

Fed Purchases

Bernanke’s speech to central bankers in Jackson Hole, Wyoming, did little to increase the already high probability that mortgage-bond investors assigned to the potential move. Trading patterns through earlier this week indicated the perceived odds rising only “a few percentage points to about 70 percent,” compared with almost 80 percent in July, Credit Suisse said.

The Fed may already be the biggest buyer in the market, after starting in October to purchase new agency mortgage securities with the proceeds from its past purchases of housing-related debt. Those included $1.25 trillion of home-loan notes from January 2009 through March 2010.

The central bank has bought $298 billion of securities under the reinvestment program, which it announced with the first round of its so-called Operation Twist for Treasuries. The central bank owns a total of about $850 billion of agency mortgage bonds, which are guaranteed by government-supported Fannie Mae and Freddie Mac or U.S.-backed Ginnie Mae.

Agency home-loan securities with the lowest coupons that are trading closest to face value, which guide consumer rates because lenders typically package new debt into them, “have limited sponsorship from the investor community other than the Fed,” according to Tae Park, a money manager in New York who oversees mortgage-bond investments at Societe Generale SA.

‘Benefiting’ MBS

“The weak job report provides a further justification for the Fed to embark on another set of MBS purchases, thus benefiting” those securities the most, he said in an e-mail.

Bond gains amid Europe’s debt crisis, concern that the U.S. economy is slowing and speculation that the Fed will expand its purchases drove down the average rate on a typical 30-year mortgage to a record low 3.49 percent in the week ended July 26, according to Freddie Mac data.

Last week, borrowing costs continued declines after a subsequent increase to as high as 3.66 percent, falling back to 3.55 percent. The swings in mortgage rates have been smaller than seen in bond yields as lenders prevent borrowing costs from declining too far to avoid being overwhelmed by a jump in refinancing, or minimize increases to maintain demand.

Download: Pimco’s Gross Says Jobs Report Will Push Fed to QE