Fixed Income Recap

It’s On
In their announcement today the FOMC (Federal Open Market Committee) left the target rate for overnight loans between banks (Fed Funds) unchanged at a range between 0% and .25%. This was completely expected, however, the comments on expanding open market operations came as a bit of a surprise.

The $500 billion agency MBS buying program announced in January, is being expanded by $750 billion to a total of $1.25 trillion to be purchased by the end of the year. There is roughly $4.4 billion in agency MBS outstanding ($2.6 billion in Fannie and $1.8 billion in Freddie), which puts Fed buying commitments at 28% of the current market. Scary!! The street was essentially split on this before today’s events. Half of the market thought they would stand pat at $500 billion and the other half thought an increase of $100-$300 billion would be substantial enough to really get the ball rolling with respect to bringing mortgage rates down. The agency debt purchasing program was also increased by $100 billion, to $200 billion, and also extended to the end of the year.

The idea of the Fed buying Treasuries has been floating around as a serious possibility for about a month now. Today the Fed committed to purchasing $300 billion in longer dated Treasuries in the next six months. The bulk of the buying will take place in the 2- to 10-year sector of the nominal curve, although purchases will take place along all parts of both the nominal and TIPS curve.

The last big piece of news that came with the FOMC announcement is the expansion of the TALF (Term Asset-Backed Securities Loan Facility). There was a loose cap on the program of $1 trillion, which is now likely to expand, but more importantly, the kinds of securities eligible as collateral under the program is set to expand. The plan is likely to still include small business loans, credit card loans and car loans, but be expanded to include the poorer performing issues.

The 30-year Treasury rallied eight points immediately after the Fed announcement, but after traders digested more of the Fed’s statement, primarily that they will be concentrating more on the middle part of the curve, the gains were cut to only five points for the day. The two-year finished up 13/32, and the ten-year was higher by four points. These are tremendous one day movements in rates. Yields on the two- and ten-year dropped 22 basis points and 48 basis points respectively. The benchmark curve flattened by 26 basis points on the day. A basis point represents .01%.

MBS
MBS reacted well to the news, but not great. Mortgages underperformed Treasuries significantly today, widening 10 to 15 basis points depending on the coupon; however yields still dropped 40 basis points across most coupons. I would expect the market to lag the news, similarly to when the Fed first announced a buying program and it took weeks before the market tightened in. The market had some of the program expansion priced in, but I would expect some further tightening to occur.

Have a great evening.

Cliff J. Reynolds Jr.
Junior Analyst