Liquidity disappears in this central corner of the US housing finance market as the Fed pulls back
Liquidity has become tight in a crucial sector of U.S. housing finance as Wall Street braces for the Federal Reserve to significantly tighten financial conditions.
Many investment banks now expect the Fed to raise key rates by 75 basis points on Wednesday, rather than the 50 basis point increase telegraphed before May’s consumer price index. shows that US inflation has yet to decline from a 40-year high.
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Adding to market pressures, the Fed also began in June to shrink its balance sheet by nearly $9 trillion, a key liquidity tap, by beginning to trim its record holdings (see chart) of Treasuries and asset-backed securities. to agency mortgages.
The Federal Reserve is looking to reduce its footprint of about $2.7 trillion in real estate bonds
Board of Governors of the Federal Reserve System
The problem is that the massive $8.4 trillion mortgage-backed securities (MBS) market began to show signs of strain, even before the Fed began to seriously cut its nearly 32% stake in the market for government guaranteed real estate bonds.
“It’s a lot of sales, people raising money,” says Scott Buchta, head of a fixed income strategy at Brean Capital, over the phone. “There were three or four days of steady selling before the Fed’s decision.”
While market conditions haven’t turned as dire as they were in March 2020, before the Fed rolled out its pandemic relief bazooka, Buchta said turmoil in the mortgage market could intensify this summer, unless other buyers step in to fill the void left by the Nourris.
Individual investors are often exposed to the agency mortgage bond market through their fixed income securities, but also through exchange-traded funds. The approximately $20.4 billion iShares MBS ETF MBB,
was down 12.1% on the year to Tuesday, while the VMBS of nearly $12.5 billion,
paid 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,
down 21.6% so far, and officially in a bear market as of Monday.
While Agency Mortgage Bonds often serve as a safe-haven play, or Treasury TMUBMUSD10Y,
bond substitute, ‘prime’ brokers at major investment banks reduced their holdings by about 12% from a year ago, according to a Deutsche Bank research report released on Tuesday, likely exacerbated liquidity problems.
“The Fed has had such a large share of the MBS market for so long,” said Mark Fontanilla, founder of mortgage analyst firm Mark Fontanilla & Co. “Now if they want to curb that, it’s a lot of paper for the market to absorb, not only from interrupted purchases, but also from whatever they would sell.
Moreover, the Fed’s pullback coincides with a more difficult environment for the housing market. Home prices have climbed about 20% over the past year, but the 30-year fixed mortgage rate has nearly doubled to around 5.2%.
“That’s about a 30% higher mortgage payment on its own,” Fontanilla said. “Not only do you need to have a larger down payment, but a 30% higher mortgage payment certainly reduces affordability.”
Additionally, as interest rates rise, so does the cost of leverage, a factor that Buchta says will make it more expensive for buyers to step in and fund deals in the sector.