Liquidity has been in short supply in a key corner of U.S. housing finance as Wall Street prepares for the Federal Reserve to drastically tighten financial conditions.
Many investment banks now expect the Fed to raise its policy rate by 75 basis points on Wednesday, rather than the 50-point increase telegraphed before the May consumer price index showed that inflation Americana has not yet reached the age of 40.
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In addition to market pressures, the Fed in June also began to reduce its balance sheet by about $ 9 trillion, a key liquidity point, as it began to reduce its record holdings (see chart) of government bonds. Treasury and mortgage securities of agencies.
The problem is that the huge $ 8.4 trillion mortgage-backed securities (MBS) stock market has begun to show signs of stress, even before the Fed begins to really reduce its its share of close to 32% in the government-backed bond market.
“It’s a lot of selling, people raising money,” Scott Buchta, head of a Brean Capital fixed income strategy, says over the phone. “There have been three or four days of steady sales, before the Fed’s decision.”
Although market conditions have not turned as severe as in March 2020, before the Fed launched its pandemic aid bazooka, Buchta said the turmoil in the mortgage market could intensify this year. summer, unless other buyers step in to fill the gap left by the pandemic. Fed.
Individual investors often have exposure to the market for agency mortgage bonds through their fixed-income holdings, but also from publicly traded funds. The approximately $ 20.4 billion iShares MBS ETF MBB,
it fell 12.1% during the year to Tuesday, while the nearly $ 12.5 billion VMBS,
loses 12.5%, according to FactSet.
Few corners of the financial markets have been immune to losses this year, with the S&P 500 SPX index,
so far 21.6%, and officially in the bear market from Monday.
While agency mortgage bonds are often used as a shelter game, or Treasury TMUBMUSD10Y,
Substitute bonds, the “main” intermediaries of large investment banks have reduced their holdings by about 12% over a year ago, according to a Deutsche Bank investigation report on Tuesday, which are likely to add to liquidity problems.
“The Fed has owned so much of the MBS market for so long,” said Mark Fontanilla, founder of mortgage analysis firm Mark Fontanilla & Co. “Now, if they want to stop that, it’s a lot of paper for the market. Absorb, not just from the interrupted purchase, but also from anything they would sell.”
In addition, the Fed’s withdrawal coincides with a tougher context for the real estate market. House prices rose by about 20% last year, but the 30-year fixed-rate mortgage rate has almost doubled to around 5.2%.
“This is a mortgage payment about 30% higher in itself,” Fontanilla said. “Not only do you have to have a higher down payment, but a 30% higher mortgage payment certainly affects affordability.”
In addition, as interest rates rise, the cost of leverage increases, a factor that Buchta said will make it more difficult for buyers to intervene and finance the sector’s operations.