Bernanke Faith in Housing Seen in Mortgage Bonds: Credit Markets

Mortgage rates in the U.S., after increasing at the fastest pace in a decade, are poised to rise even further with Federal Reserve Chairman Ben S. Bernanke saying the central bank is ready to slow its purchases of Treasuries and bonds backed by housing loans.

Yields on Fannie Mae’s 3.5 percent, 30-year securities have soared 0.38 percentage point in the past two days to a 19-month high of 3.1 percent. The price tumbled 1.3 cents yesterday, the most since 2010, to 102 cents on the dollar, before falling to 101.6 cents as of 12 p.m. in New York. The average rate on new loans packaged into such bonds rose last week to 3.98 percent, the sixth straight increase, from 3.35 percent at the start of May, Freddie Mac surveys show.

Bernanke said at a news conference in Washington yesterday that the rise in mortgage rates hasn’t been “so dramatic” as he suggested the housing market may be strong enough to withstand higher borrowing costs. Investors sold bonds that guide home-loan rates as they focused on his expectation that the Fed’s $85 billion in monthly debt buying will slow later this year and end around the middle of 2014.

The tone of Bernanke’s comments was “very assuring and soothing, but that’s like a mother telling her baby that she will be leaving in a very gentle voice,” said Tae Park, a money manager in New York at Societe Generale SA who focuses on mortgage bonds. “The baby will still have a fit.”

Quantitative Easing

The Fed chairman also said the central bank’s holdings, including $1.2 trillion of housing debt, should continue to depress yields. Policy makers don’t expect to sell mortgage bonds soon and any changes in their purchasing plans will depend on economic conditions, he said.

Wells Fargo & Co., the largest U.S. mortgage lender, is offering 30-year fixed-rate loans at 4.5 percent, according to its website, up from 4.13 percent on June 18 and 3.88 percent on May 22, when comments by Bernanke to lawmakers and the release of the minutes of the last Fed meeting caused bonds to plummet. Freddie Mac’s survey, which is lagging behind the bond slump because it reflects originator responses through yesterday, showed average rates falling to 3.93 percent this week.

Following a five-year slump, its worst since the Great Depression, housing began to recover last year, fueled in part by mortgage rates that reached a record low 3.31 percent in November after the Fed started its third round of debt buying known as quantitative easing.

Housing Recovery

Asked by a reporter whether rates exceeding 4 percent would derail the rebound, Bernanke said that “one important difference now is that people are more optimistic about housing” and surveys show they expect prices to climb further.

“And that, you know, compensates to some extent for a slightly higher mortgage rate,” he said.

Home prices in 20 metropolitan areas soared 10.9 percent in the 12 months through March, the biggest gain in seven years, as residential real estate is also bolstered by an influx of institutional buyers, limited supply and an improving job market, according to S&P/Case-Shiller index data released May 28.

Bernanke was too “dismissive” of the impact of higher mortgage rates, Pacific Investment Management Co.’s Bill Gross, manager of the world’s biggest mutual fund, said today in a Bloomberg Radio interview with Tom Keene and Michael McKee. Increases since September have boosted the monthly payments on a typical new home by about 20 percent, he said.

‘Not Reflective’

His view is “not reflective of what may lie ahead in terms of housing prices and the real economy,” Gross said.

While Fed officials have been a “little puzzled” by the speed of increases in interest rates relative to inflation expectations, the housing market could perform well with higher borrowing costs, Bernanke also said yesterday.

“If interest rates go up for the right reasons -- that is, both optimism about the economy and an accurate assessment of monetary policy, that’s -- that’s a good thing,” he said. “That’s not a bad thing.”

Economists surveyed by Bloomberg forecast the U.S. will grow 2.7 percent in 2014, up from an estimated 1.9 percent this year. The Conference Board’s index of consumer confidence rose to 76.2 in May, the highest since February 2008, according to data from the New York-based private research group.

Unwind Stimulus

Bernanke’s comments on housing were among the most important to emerge from the news conference, said Scott Buchta, head of fixed-income strategy at New York-based brokerage Brean Capital LLC.

“He does not appear to be alarmed about the sharp rise in rates, nor is he saying anything to force the opposite,” Buchta said. “The Fed probably can live with mortgage rates above 4 percent so long as the economy shows continued growth.”

When the central bank eventually decides to unwind its record stimulus, most members of the Federal Open Market Committee no longer will want to sell holdings of agency mortgage bonds, Bernanke said.

“A strong majority now expects the committee will not sell agency backed mortgage-backed securities during the process of normalizing monetary policy, although in the longer run, limited sales could be used to reduce or eliminate residual MBS holdings,” he said.

Default Swaps

A confirmation of that shift from a 2011 plan should help the debt outperform Treasuries, Deutsche Bank AG’s Steven Abrahams said yesterday in a note to clients before the Fed news. The mortgage-bond strategist’s expectation was for the central bank to start tapering its purchases in September, and then drop them by a third every three months before wrapping up the buying in March.

Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. rose. The Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, increased 4.6 basis point to a mid-price of 90.3 basis points as of 12:27 p.m. in New York, according to prices compiled by Bloomberg.

The index typically rises as investor confidence deteriorates and falls as it improves. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

The U.S. two-year interest-rate swap spread, a measure of debt market stress, increased 2.95 basis points to 19.3 basis points as of 12:27 p.m. in New York. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as company debentures.

Bonds of Chevron Corp. are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 3.3 percent of the volume of dealer trades of $1 million or more as of 12:26 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The Bloomberg Global Investment Grade Corporate Bond Index has gained 0.27 percent this month, paring the decline for the year to 1.5 percent.

Before it's here, it's on the Bloomberg Terminal.