CHART OF THE NIGHT: Here's Why The Fed Might Start Buying Up Mortgages

The buzz tonight: Fresh reports about how the Fed might buy more mortgage-backed securities in a scheme to suppress rates.

At this point, everyone’s supposed to say: What’s the point of that, lower rates aren’t helping anything, so what will further downward pressure on rates accomplish?

Well it is true that rates are low, but… ever since QE2 ended, the gap between mortgage rates and the 10-year risk free rate has grown considerably, as this chart from Nomura shows nicely.

mortgage spread

Photo: Nomura

Basically, the chart represents the decline of risk assets following the end of QE2.So there would seem to be room for the Fed to step in as a buyer of MBS, and compress the gap between mortgage rates and yields, even if mortgage rates are already super-low.

Whether that would have any real impact on the housing market, remains an open question.

Meanwhile, in Nomura’s daily commentary, the latest commentary from Fed Governor Tarullo, in which he calls for this action, is disected, and the conslusion is that the speech was significant, since a) Tarullo is in close contact with Bernanke, being based in DC, and B) Since he’s a lawyer, this kind of big econ policy speech is fairlyr are.

Here’s Nomura:

One major take away from the outcome of the September FOMC meeting, which was affirmed by last week’s release of the minutes, was that MBS purchases were back on the table should the Fed ease further (see “Tools of the Trade”, US Roundup, 14 October 2011). In a speech tonight, Federal Reserve Governor Daniel Tarullo has provided more support for our view. Tarullo made the case for the return to large-scale MBS purchase program. He said the impact would be similar to purchasing Treasuries, which the Fed did in its last round of asset purchases, as well as yield more benefits. He said the impact would be, “inducing investors to shift to other assets, including bonds and equities. But it could also have more direct effects on the housing market. By increasing demand for MBS, such a program should reduce the effective yield on MBS, which in turn should put downward pressure on mortgage rates. The aggregate demand effect should be felt not just in new home purchases, but also in the added purchasing power of existing homeowners who are able to refinance.” Tarullo’s speech is especially notable because it is unprecedented for him to break new ground with regards to monetary policy, as he has done with this speech. He is a legal scholar and focuses more on the supervisory and regulatory aspects of the Fed. Tarullo is on the Board in DC, which means he’s spending time with Chairman Bernanke and Vice Chair Yellen day-to-day. In our view, it’s reasonable to surmise that further MBS purchases are gaining traction from core FOMC members, such as Chairman Bernanke, Vice Chair Yellen, and NY Fed President Dudley.

Read Tarullo’s full speech here >

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