Taper Tantrum Erased With Mortgage Yields at 16-Month LowJody Shenn
In the market for U.S. mortgage bonds, it’s almost as if the turmoil that became known as the taper tantrum never happened.
Yields on government-backed securities that guide home-loan rates have dropped to the lowest in 16 months, erasing most of the increase triggered last year when the Federal Reserve signaled it would start scaling back its rate-suppressing stimulus measures. Benchmark Fannie Mae notes fell to 3 percent as of 11 a.m. in New York, from as high as 3.81 percent in September 2013.
The rally is lending a hand to Fed policy makers who are laying the groundwork for an eventual move to raise their interest-rate benchmark without thwarting a housing recovery that they said last month “remains slow.” Yields are being pushed lower by subdued inflation and efforts by central banks worldwide to bolster their economies even with the Fed on track to end its purchases of Treasuries and mortgage bonds this month.
“There’s so many people reaching for yield right now that, unless there’s a shock to these markets, the general trend is for prices to go up and yields to be very, very low,” said Laird Landmann, co-director of fixed-income at TCW Group Inc. The firm, which oversees about $145 billion of assets, holds a smaller share of the debt than found in benchmark indexes.
After falling 1.4 percent in 2013 in what was the first annual loss in 19 years, U.S.-backed mortgage bonds returned 4.99 percent this year through yesterday, or 0.47 percentage point more than similar-duration government notes, according to Bank of America Merrill Lynch index data. The gains continued after minutes released yesterday of a Fed meeting last month stoked speculation that policy makers’ concerns about the economy will delay a move to raise rates.
Lenders including Quicken Loans Inc. today offered 30-year, fixed-rate mortgages for less than 4 percent for the first time this year, according to Brean Capital LLC. The average rate on typical new 30-year mortgages has dropped 0.5 percentage point in the past year to 4.3 percent after climbing from a record-low 3.47 percent in December 2012, according to Mortgage Bankers Association data through last week.
Mortgage bonds will likely beat Treasuries again over the next year, especially if issuance continues to be limited while the outlook for rate volatility remains muted and Fed-fueled distortions persist in a market that investors often use to finance trades, Deutsche Bank AG analysts led by Steven Abrahams wrote yesterday in a report.
Richmond Fed President Jeffrey M. Lacker bemoaned the central bank’s acquisitions of $1.7 trillion of mortgage bonds in a Wall Street Journal op-ed this week. Lacker, a member of the Fed’s policy setting committee, and John A. Weinberg, director of research at the Richmond Fed, said the purchases were inappropriate because they favored home-loan borrowers over others.
“Normalization should include a plan to sell these assets at a predictable pace, so that we can minimize our distortion of credit markets,” they wrote.
Purchases of previously owned houses unexpectedly dropped 1.8 percent to a 5.05 million annual pace in August, according to National Association of Realtors data. The median forecast of 72 economists in a Bloomberg survey called for sales to rise to a 5.2 million rate.
The Fed is ending mortgage-bond purchases it started in September 2012 to stoke a sluggish economic recovery, acquiring $40 billion of the debt each month until this past January. Since then, it’s slowed the pace by $5 billion at each of its policy-setting meetings and if it continues on that path, the central bank would end them at its Oct. 29 gathering.
The central bank will still absorb some of the market’s issuance because it continues to reinvest proceeds from current holdings, which will fuel about $20 billion of purchases during its next monthly round, according to BNP Paribas SA analysts.
Policy makers said Sept. 17 that they wouldn’t stop that program until after the Fed begins raising its benchmark for short-term interest rates. Without that step, investors would face about $200 billion more of new bonds coming to the market next year, according to Barclays Plc analysts.
The $5.4 trillion market expanded by only about $50 billion in the first nine month of this year, according to BNP, down from about $250 billion last year and a quarter of the $200 billion that the Fed has added to its balance sheet in 2014.
Mortgage-bond prices also are getting a boost from muted volatility, which gives investors comfort that they won’t get their principal back faster or slower than they want as the rate of borrower refinancings fluctuates. Merrill Lynch’s MOVE index, which measures price-swing expectations, shows a 45 percent decline since its 2013 peak.
Volatility should reach its lows at the end of the Fed’s debt buying, posing “a modest risk to MBS performance,” the Deutsche Bank analysts wrote.
One way in which Los Angeles-based TCW is still investing in the market is by taking advantage of the cheap financing for investors using so-called dollar rolls, an imbalance created by the Fed’s purchases, Landmann said.
For one type of Fannie Mae bond, that strategy -- which involves simultaneously agreeing to buy and sell bonds for delivery in different months -- is now offering borrowing costs of about negative 0.3 percent, according to data compiled by Bloomberg. That boosts returns that would otherwise look less attractive.
“Prices are expensive out there for just about every asset class,” Landmann said yesterday in an interview at Bloomberg News headquarters in New York.