FED DESPERATION HITS: Get Ready For The Mother Of All Yield Chases

In a time when investors are looking for new and innovative solutions to a languishing economy, word leaks of a potential return to the Fed’s bread & butter: Large Scale Asset Purchases (LSAP’s) of massive amounts of Agency MBS.

Since the conclusion of QE2, we’ve witnessed many barometers of the risk trade sell off including High Yield spreads blowing out to over 800bps from a February low of under 400bps.  Similarly, loss-adjusted yields on non-agency MBS have widened (from 4-5% back to higher single digits) during the same time period.

Everyone realises that there is very minimal incremental benefit to driving primary mortgage rates lower when the elephant in the room is the tens of millions who cannot refi.  Outside of the same high quality borrowers who many refinance again, the obvious objective is likely to just prop up risk asset classes that have fallen.  

Since the flattening of the yield curve, institutions are having to make hard decisions on whether or not to extend duration and/or add credit risk to maintain margin.  Another round of MBS purchases would only increase this struggle.  It is obvious that investors would be driven into IG corporates, HY, various ABS, and muni’s among others.  

More importantly, is the Fed in such a dire situation where this is the best thing left on the table?  How does the market react?  The last rounds clearly show the impact was temporary at best, or dare I say transitory?  After my initial response of yawning, are we really in this bad of a predicament?

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