Fed Finds A Way To Stay Involved In Mortgage Market

By Prabha Natarajan
Of DOW JONES NEWSWIRES
NEW YORK -(Dow Jones)- The Federal Reserve will continue to use a portion of its mortgage-backed securities program beyond the planned exit on March 31, giving the market a much-needed stabilizing force.
The January Federal Open Market Committee meeting minutes, released Wednesday, noted that the Federal Reserve would continue to use dollar roll transactions after March 31. This was a confirmation of what market participants had anticipated.
"The Fed will use rolls to keep funding at normal level," said Kumar Velayudham, an agency mortgage analyst with Barclays Capital.
Essentially, dollar rolls come into play when a buyer agrees to sell a bond in a current month and agrees to buy back the same trade in a future month at a lower price. This is a financing vehicle for owners of mortgage collateral, who give the bonds to dealers for cash, and get like securities back a month later.
This is an important part of the $5 trillion agency mortgage world, and is key to maintaining liquidity. While the rolls don't directly have an impact on mortgage rates, they determine what securities investors buy and sell.
The Federal Reserve's $1.25 trillion mortgage purchase program has made the central bank the main source of funding almost to the exclusion of all others.
Now, with the Fed essentially saying it won't take delivery on the $92 billion of securities that it already owns until a later time, it eases the distortion caused by the central bank's insatiable demand.
"The Fed's patience in taking delivery of bonds it already owns reduces the distortion in the market that the Fed's presence has caused," said Paul Jacob, research director at Bank of Manhattan Capital, in Manhattan Beach, Calif.
Additionally, it provides the central bank with a vital tool to keep tabs on the market. As the FOMC minutes note, "While the timely settlement of all agency MBS purchases remains a priority, the continued application of this tool during settlement will help preserve the Federal Reserve's ability to support market functioning in light of the volume and pace of agency MBS program purchases."
Essentially, the Fed's dominating presence will give it the ability to maintain a balance, and ensure that mortgage bonds don't become too scarce or too plentiful.
Despite the Fed's efforts to create a balance, some securities continue to be too rich, said Barclays' Velayudham. As example of this are those with 5% and 5.5% coupons, since the Fed's purchase of these securities have exceeded supply, thus creating a demand for these securities.
"The Fed is doing all it can, but it's difficult to remove all the distortions it caused," Jacob said.
-By Prabha Natarajan, Dow Jones Newswires; 212-416-2468; prabha.natarajan@dowjones.com
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