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Fed’s Dudley Sees Obstacle in Mortgage Bond, Rate Spreads

Federal Reserve Bank of New York President William C. Dudley
For the Fed’s stimulus to achieve its “full impact,” Federal Reserve Bank of New York President William C. Dudley said, lower yields on mortgage-backed securities must pass through to interest rates on home loans. Photographer: Ramin Talaie/Bloomberg

Federal Reserve Bank of New York President William C. Dudley said a wider gap between yields on mortgage-backed securities and home loans is reducing the potency of the central bank’s monetary stimulus.

While there is “solid evidence” the Fed’s monthly purchases of $40 billion in housing debt have been effective in lowering yields, “the impact of monetary easing on the economy through housing and mortgage finance has been impeded to some degree,” Dudley said today in opening remarks at a workshop on mortgage rates held at the New York Fed.

For the Fed’s stimulus to achieve its “full impact,” he said, lower yields on mortgage-backed securities must pass through to interest rates on home loans. “To the extent that the primary-secondary rate spread widens, the reduction in pass-through limits the full impact of the policy actions,” he said.

The central bank announced its third round of large-scale asset purchases on Sept. 13 to boost growth and reduce unemployment stuck near 8 percent three years into the expansion. Dudley said last week he is focusing on elevated joblessness as he considers whether the Fed should increase its asset purchases.

“The unemployment rate remains unacceptably high,” Dudley said today. The policy-setting Federal Open Market Committee, which meets Dec. 11-12, “will continue its purchases of agency MBS, undertake additional asset purchases and employ its other tools as appropriate until there is a substantial improvement in the outlook for the labor market in a context of price stability.”

‘Strong Case’

Boston Fed President Eric Rosengren said he sees a “strong case” for the central bank to buy bonds at the current monthly pace of $85 billion after the expiration of Operation Twist, in which the Fed swaps $45 billion of short-term Treasuries for longer-term debt.

“Given the tepid economic recovery, high unemployment, and subdued inflation -- and the uncertainty around fiscal policy -- I believe an accommodative monetary policy is quite appropriate,” Rosengren said today in a speech in New York. “We want to see continued improvement in labor markets in the near term, and monetary policy should encourage faster economic growth to achieve that objective.”

St. Louis Fed President James Bullard said replacing Operation Twist with outright purchases of the same amount of Treasuries would represent a policy easing that could risk higher inflation.

‘More Impact’

“It is reasonable to think that an outright purchase program has more impact on inflation and inflation expectations than a Twist program,” Bullard said today in a speech in Little Rock, Arkansas. He told reporters after his speech he would favor outright purchases of about half the current rate of Operation Twist.

Dudley said tighter mortgage underwriting standards and challenges for homeowners wanting to refinance are blunting the impact from Fed easing.

The difference between yields on Fannie Mae mortgage bonds lenders typically use to package new loans for sale and 30-year new-loan rates is more than 1.2 percentage point, about the same as when the Fed announced additional buying in September, according to data compiled by Bloomberg and That’s up from about 0.8 percentage point in March and compares with a median of about 0.4 percentage point during the last decade.

The Standard & Poor’s 500 Index fell 0.5 percent today to 1,409.46 in New York, while the 10-year Treasury note yield was little changed at 1.62 percent in New York trading, according to Bloomberg Bond Trader data.

The Institute for Supply Management’s factory index decreased to 49.5, the lowest since July 2009, from 51.7 a month earlier, the Tempe, Arizona-based group said today. Economists projected the index would ease to 51.4, according to the median forecast in a Bloomberg survey. A reading of 50 marks the dividing line between expansion and contraction.

Download: Dudley Says Jobs, Inflation to Impact Bond Buying

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