Futures Outlook - An Excerpt from CRB'S Futures Market Service

Conclusion of Fed’s mortgage security purchase program could push mortgage rates 50 bp higher

The FOMC at its latest meeting on March 16 confirmed that its mortgage security purchase program will end in two weeks by March 31. The Fed in its year-long program has purchased $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt.

Mortgage rates generally trade at fairly predictable spreads about Treasury rates. In the past 10 years, the spread between the 30-year mortgage rate and the 10-year T-note yield has averaged 184 bp and the spread against the 30-year T-bond yield has averaged 134 bp. The 30-year mortgage rate is currently trading only 125 bp above the 10-year yield, which is 59 bp below the 10-year average of 184 bp, and only 33 bp above the 30-year T-bond, which is 100 bp below the 10-year average of 134 bp.

The fact that mortgages rates are trading at such an abnormally low level compared to Treasury yields is a direct result of the Fed’s massive $1.25 trillion mortgage purchase program. Once the Fed steps out as such a massive buyer, then mortgage rates are likely to rise back to more normal spreads in order to attract new buyers. Private investors will be much more sensitive to yield than the Fed, which bought the securities, not because they offered an attractive return, but because the Fed from a policy standpoint wanted to keep mortgage rates down and revive the mortgage securitization market. A return to “normal” spreads suggests that the 30-year mortgage rate could rise by at least 50 bp in coming weeks as the mortgage market tries to find new buyers for its securities. The 30-year mortgage rate is currently trading at 4.95%, which is an extremely low level from an historical perspective and is only 24 bp above the record low of 4.71% posted in early-December 2009. A 50 bp rise in the mortgage rate to 5.50% would certainly not be helpful for the U.S. housing market, which still needs all the stimulus it can get. Nevertheless, even a 5.50% mortgage rate is near the lowest levels seen in 2003-08 and may be low enough to help the housing market to eventually work through the current overhang of homes on the market.

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