Mortgage bond investors are about to become reacquainted with 'moral hazard' and its inevitable consequences.
As the Federal Reserve continues to pull out of US Treasurys and mortgage bonds (the Fed entered its "peak" monthly unwind phase in Q4, where it will allow up to $30 billion and $20 billion in MBS to roll off and on Oct. 31 its balance sheet declined by more than $33 billion, the largest one-week drop since the start of QE), holders of housing bonds who had grown accustomed to steady returns in a rigged market endured their biggest shellacking in 2 years, as Bloomberg pointed out in a story published Friday.
And while at least one prominent bond investor pointed out that Bloomberg's warnings about a "bloodbath" in MBS may have been exaggerated...
Ridiculous BBerg News story today on the (non-existent) “bloodbath” in the mortgage-bond market in Oct. MBS Index Return: -.6%. LQD: -2.1%.— Jeffrey Gundlach (@TruthGundlach) November 2, 2018
...the story's central premise that the retreat of the bond market's 'marginal buyer' is creating headaches for complacent bond bulls is certainly valid, as we've said before. It only takes a quick glance at the 10-year-yield vs. the Fed's balance sheet expansion/unwind to spot the dangers that could lie ahead.
Now, as the Fed-generated tidal wave of liquidity slows to a trickle and the central bank looks to unwind some $1.7 trillion in MBS holdings, "savvy" bond bulls are stuck asking themselves: who the hell is going to step in and stop the bleeding once liquidity dries up further and mortgage bonds continue to fall?
The answer isn't immediately clear.
Kevin Jackson, a managing director on Wells Fargo’s mortgage trading desk recently told Bloomberg:
"When the Fed announced they were going to buy mortgages, we tightened a lot and rolls performed really well - now the reverse is happening. One should expect widening."