Good Afternoon,
I think it may possible if one can reason out the aim of their recent balance sheet expansion. It seems the FED’s recent MBS purchases are the key driver in expanding their balance sheet. Intuitively it would seem this is being done because they are expecting weakness in this market, however I am not shorting this market right now. I think the increase this month in MBS purchases by the FED are a reaction to Goldman and other professionals decreasing exposure to this asset class and the FED working to maintain tight MBS spreads relative to corporate credit.
The mantra of “don’t fight the Fed,” that has been indoctrinated into most participants over the past twenty years and seems to have held. I do not understand the FED’s strategy and the importance they seem to be placing on maintaining these spreads. I can only hypothesize as to what market participants can sell to them as they continue to push this boulder up a hill. Aside from their stated intention:
“These programs were introduced with the explicit aim of reducing mortgage interest rates.”
This intention will help keep home values up, provide homeowners lower monthly payments, and increase property tax revenue. I would like to understand why the FED is placing such an emphasis on maintaining the mentioned spreads, as I believe it could offer more precise DOTs to their interest rate plans, which I believe they intentionally keep vague. The risks the Fed is taking by increasing these purchases is it will encourage poor credit standards in this sector and could fuel bubbles.
The questions I am looking to answer to get a more educated perspective are; what markets participants are selling the FED overpriced securities, how are these market participants hedging these sales, and why is the Fed is purchasing them? Below is my perspective, if anyone thinks I missed something important, please send me an email at sales@unreformedandbroker.com .
A solid overview of the Mortgage-Backed Securities market is detailed on the Fed’s website:
Not many institutions can fill such large MBS orders. So delving into who is going to get the best deal…
My assumption is the initial movers to sell at this artificially depressed ten-year rate will get the best deal, as these purchases are front running interest rate increases, that may come sooner than expected. This is just a hunch; I have no evidence or knowledge to support this. The initial seller could also be the focus of the below investigation.
To determine this, I looked at the below auction schedule:
Considering my attention span, I am going to ignore the Ginnie Mae auctions, even though this is a 5.5 of a 7.5 trillion-dollar markets. I am ignoring them because most of the purchases are going to be going to be 15 and 30 Uniform mortgage backs, which is significant considering the relative sizes of the markets. It seems the FED is specifically using the 15-and 30-year Uniforms to tighten the mentioned spreads as opposed to the Ginnie Maes. I am assuming by focusing on the smaller asset class they plan to drive the prices up more easily via correlations . It seems they assume as investors will look to arbitrage prices between the two asset classes. I think a more prudent strategy is to just front run their auction dates and sell into them.
I am also going to assume Bank of America will be selling into this considering their position size, but doubt they are behind suppressing rates, as such a move would cost them more than they could recoup on the MBS sales. This is most likely the case with the rest of the banks, and I am assuming they will be hedging by front loading the yield curve in various manners.
Other notable asset holders in this space are Real Estate Income Funds, such as Blackstone’s “Brief” and “Breit” fund.
I am using these funds as an example because I do not invest in Blackstone Investments. I disliked the Chairman reneging on his promise to donate to public schools.
Anyway, using these funds as an example. I expect as they sell into this they will continue to allocate more into multifamily rentals, floating rate debt instruments, and possibly hospitality, if they can find any good deals resulting from the stress of COVID. However, these expectations are just a guess, especially regarding hospitality as they could be pushing up against position size and diversification issues considering their existing exposure.
My expectation is that the NAVs of these funds will increase with the FEDs help. This is just a guess, as is my assumption that they will decrease in value sooner than expected. These guesses are predicated on my expectation that interest rates will rise sooner than forecasted. I am going to stay away from these type of funds as I like to trade intraday and am concerned about their over exposure to the hospitality industry.
I may however chip Funds with Uniform MBS exposure on slow days with the below ETFs, using the ten-year and auction dates to time the trades, as I am not sure the expected correlations will flow through to the rest of the market.
Warmest Regards,
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