Those following day to day flow (buys and sells) data of Treasurys and MBS by the Fed, are aware that in the past few months Ben Bernanke's net purchases of MBS have declined modestly. Naturally this is not due to a stated policy of tapering one or more purchasing programs (at least not yet), but due to what appears to have been a drop off in origination, as confirmed by recent plunging mortgage applications data (and which today literally crashed out of bed). So is this net change in Fed flow, in a world in which Fed flow is all that matters (sorry "Stock" purists: 2009 called, they want their discredited ideas back) an indication of stealth Fed tapering? Read on for Cashin's explanation.
From Art Cashin of UBS
Tapering vs. Supply And Demand – Last week, three members of the FOMC called on the Fed to end a portion of their Quantitative Easing (QE) program.
The portion that the three wished to end was the Fed's purchases of mortgage backed securities (MBS). The three amigos struck two chords. First, the housing market had rebounded enough that it should be taken off life support.
More importantly (to us, at least), were their indications that continued Fed purchases in the MBS area could be disruptive and counterproductive. They were already influencing (negatively) the efficiency of that market.
We have noted for weeks the risk of the Fed staying full throttle as the numbers of treasury bonds and mortgage bonds were starting to decrease. There were some estimates that the Fed was already purchasing 90% of the MBS issuance.
When I have a question on mortgages, I turn to my good friend, Barry Habib, who is the resident genius on the topic. (Actually, Barry is the resident genius on lots of things financial, but I don't want to give him a big head – well-deserved or not). Anyway, this was Barry's comment:
As you know, the Fed has been stating that they will purchase $40 billion in Mortgage Backed Securities (MBS) and $45 billion in Treasuries, for a total of $85 Billion each month. However, the Fed has actually been purchasing much more than that because of reinvestment of principal from refinance loans and principal payments. Earlier this year, they were purchasing over $80 billion per month in MBS alone. This is more than double the amount the Fed stated they would be purchasing. But over the past two months, the Fed has eased up a bit on the gas pedal, as these purchases are now closer to $65 billion per month. This is still obviously more than the advertised $40 billion, but less than what we had seen earlier this year.
Has a little tapering already begun? The answer is no. We believe that the slowdown in Fed purchases is due to fewer loans being originated for refinancing in March, when rates had spiked.
Barry went on to note that the resultant drop-off in MBS paper may have prompted the Fed to scale back purchases (lest they disrupt the markets thoroughly).
He pointed out that there was a burst of refinancings in April (nailing down low rates before they rise?). Those loans will close in June, which could result in a new flurry of "paper" for the Fed to buy.
If the Fed does return in earnest, it could cause a mild rally in MBS paper in general. So, added supply could reignite the Fed whose activity could then raise prices. Lewis Carroll would have loved it. Thanks Barry!