Monday, July 13, 2009

Still think the Fed lost control of rate setting?

Before last Fed meeting back in June there were claims that the Fed has lost control of setting interest rates and that the central bank would "say something" in its statement at the meeting to "try" to get rates to move lower.

Well, it went one better. Here's what is said in the statment:

"...the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn."

On June 24 reserve balances, Fed Treasury holdings and interest rates looked like this:

Reserve balances on 6/24: $692 billion
Treasuries held as of 6/24: $647 billion
10-year Treasury interest rate on June 24: 3.72%

On July 8, it looked like this

Reserve balances as of 7/8: $751 billion
Treasuries held as of 7/8: $669 billion
Yield on 10-year Treas: 3.3%

Fed said it would buy Treasuries. Fed bought Treasuries. Interest rates on Treasuries came down. Case closed.

By the way, notice in that statement the Fed also said it would buy mortgage-backed securities. It hasn't done so yet, but it will. So if you are shopping for a mortgage, wait!! Mortgage rates will come down.

"Interest rates are a parameter set by the central bank, period!" -Economist James Tobin


Anonymous said...

Hi Mike,
If people wait it might be too late. It's important to understand rate locks are tied to a social security number and a credit score so at minimum a loan application must be on file with the lender or broker that will facilitate the new loan. I always tell people, it's free to find out and it's free to wait. But indecision always has a cost.

mike norman said...

Yes, Warren also said that any further purchases of Agency MBS by the Fed may already be "priced in" to current yields. That part I doubt because $800 billion more in Agency MBS still has to be bought for the Fed to hit its $1.25 goal by the end of the year. However, i realize that many things go into the rate that borrowers pay and, having said that, you are the expert, and I would advise anyone reading this to listen to you and contact you if they need help?

STF said...

Hi MIke

Agree with your post. The problem is, the Fed's operations are ALWAYS about price. So, they should simply say . . "we want the 10y Tsy to be 3%" or whatever it is they want it to be. The way they are going about it, by saying they will buy $X in Tsy's, nobody knows their target. It might take a lot fewer purchases of Tsy's to get to their target if they'd just announce it.

For that matter, what's the point of targeting Tsy's? To bring down those other rates tied to them . . . so why not just buy those other assets instead and announce a desired markup above the Tsy.

If the Tsy isn't low enough already to get the other rates to desired level after markup over Tsy, then they could buy Tsy's, too and announce the desired rate, but mortgage rates, for instance, are trading well above historical spread above Tsy's. So, why not announce "we will buy ABS related to conforming mortgages at a 1.5% spread above 10y Tsy"? Is there any doubt that 30y conforming mortgage rates would quickly go to that spread?

Scott Fullwiler

MortgageAngel said...

"Warren also said that any further purchases of Agency MBS by the Fed may already be "priced in" to current yields" - Totally! We saw this last November when the they announced they would 'begin' buying mbs. Bond traders immediately began buying following week in fact, the rally that broke loose in December pretty much peaked out by the time the Fed entered the market. Makes you wonder where we'd be today had they not planned to continue buying mbs past June 30.

MortgageAngel said...

That makes sense - why not? Very interesting!

How can a "free market" survive in this information era?

Matt Franko said...

Mike & Scott
Hope you see this post.
Right or wrong the Fed seems to be using market mechanisms to influence interest rates.
Ive been following the NY Fed purchases of MBS here.
As of last week, if you go back and add it up, the NY Fed has net purchased $638.6B of MBS since the start in Jan 09, but the trades have not all settled for some reason and the Fed H.4.1 only shows $462.5B purchased with the new reserves as the fed only accounts for the purchases until after settlement. This lag between the NY fed MBS purchases and final settlement is approaching $200B.
Mike I have to agree with your call for a near term MBS/Treasury rally (and corresponding better rates) as the last time this lag maxed out at (only!) $150B in Feb, all of the $150B of new reserves came flooding in in just 1 week for some reason (huge trade settlements in one week) and we had the 40-year historic 1-day rally that week in Feb. I would not want to be short MBS or treasurys with $200B of new reserves backed-up and ready to flood in any week now.
I dont understand why these trade settlements are taking so long from the trade date? and resulting in these lumpy inflows of reserves...

Heres the running totals at the NY Fed:

WeekEnd MBSPur Total
1/7 10.2 10.2
1/14 23.4 33.6
1/21 19.0 52.6
1/28 16.8 69.4
2/4 22.3 91.7
2/11 23.2 114.9
2/18 19.9 134.8
2/25 25.0 159.8
3/4 30.1 189.9
3/11 27.1 217.0
3/18 19.7 236.7
3/25 33.2 269.9
4/1 32.9 302.8
4/8 30.4 333.2
4/15 21.8 355
4/22 26.2 381.2
4/29 23.1 404.3
5/6 25.4 429.7
5/13 27.1 456.8
5/20 24.7 481.5
5/27 25.5 507
6/3 25.8 532.8
6/10 23.0 555.8
6/17 20.3 576.1
6/24 22.3 598.4
7/1 23.1 621.5
7/8 17.1 638.6

Matt Franko said...

Follow up to above comment:

Correction: Big settlement and subsequent bond rally was in March vice my citing February above. Apologies.

Was trying to figure out who was selling these MBS to the Fed. Checked out the June 11,2009 z.1, page 88, Schedule L.210, Line 6 Household Sector: At end of 2008, it reports the Household Sectors holdings of these Agency and GSE backed securities was $740.7B , three months later at end of Q1 2009 household sector held $396.7B: Household sector net sold nearly $350B of MBS in Q1. Fed only bought $236B MBS by end of Q1.
So looks like the Fed may have effectively bought these MBS from the household sector on net, as this sector had the most significant liquidation of MBS that quarter.
Both page 88 (MBS) and 87 (US Treasury Holdings)of June's z.1 are interesting for Q1.


mike norman said...


You said:

" why not just buy those other assets instead and announce a desired markup above the Tsy."

That would be too logical!

mike norman said...


Excellent analysis!!