ANALYSIS - U.S. Fed curbs agency purchases in 'calculated' move

Thu, Nov 5 09:53 AM

The Federal Reserve's planned cutback in agency debt purchases may be a move to reassure financial markets it won't make sudden shifts as it unwinds its massive support, analysts said.

The Fed on Wednesday said it would pare its total buying of unsecured debt of federal housing agencies to about $175 billion from a previous commitment of up to $200 billion, citing limited amounts of debt sold by Fannie Mae, Freddie Mac and the Federal Home Loan banks.

Fed purchases of the debt soaked up the bulk of mortgage-related issuance this year, aiding affordability and recovery in the housing market. Investors are concerned the value of holdings could fall should the stimulus disappear.

Despite being billed as a technical move by the Fed, some economists saw the reduction as a low-risk reminder by the central bank to investors it will wean the markets off its support in a gradual way.

"This is all part of the tweaking process as we approach the end of accommodation," New York-based analysts at RBC Capital Markets, led by Ira Jersey, said in a client note. "In our view, this agency decision had the lowest risk of "disturbing the market".

SLOW RETREAT

How the Fed exits its "quantitative easing" policy has been among the most hotly debated issues for investors because prices in agency, Treasury and mortgage bond markets have all come to rely on federal purchases.

Withdrawing $25 billion of purchases may look like pocket change, compared with the Fed's massive emergency support that has more than doubled its balance sheet to $2 trillion.

It is a small amount compared with the roughly $3 trillion market for debt issued by Fannie Mae and Freddie Mac to support mortgage purchases.

But for the Fed, winding down its programs could be a step, albeit gingerly, toward tightening credit.

Lowering the total agency buys is "a very calculated step," said Scott Graham, head of U.S. debt syndicate at RBS in Stamford, Connecticut.

"The end of quantitative easing, or the reduction of direct government support for the marketplace, is going to have to be measured and over a period of time," said Graham.

Reducing agency purchases comes about a week after the Fed made its last purchase of U.S. Treasury debt, which itself also had no "catastrophic" impact on rates used to guide consumer and corporate borrowing costs, Graham noted.

Yield premiums on agency debt, which is used to support Fannie Mae's and Freddie Mac's mortgage security investments, rose by 0.3 to 0.5 percentage point on Wednesday, a modest move given typically slack demand near year end, said RBS's Graham.

A NOD TO HAWKS

The Fed may have chosen to back off a market where it is simply not needed. Portfolios of Fannie Mae and Freddie Mac -- which hold mortgage-backed securities they issue -- are set to shrink beginning next year per mandates set when rising losses pushed them into full government control last year.

The Fed has also vowed to buy $1.25 trillion in mortgage-backed securities under a program it plans to taper to a conclusion by the end of the first quarter of next year.

While the Fed is slowing its purchases of mortgage-backed securities, it is still the largest buyer of the bonds.

With average fixed-rate long-term bond issuance by the housing agencies at about $11 billion a month over the last four months, the central bank's purchases at its rate until now would soak up the entire new supply, said Jim Vogel, a strategist at FTN Financial in Memphis, Tennessee.

If the Fed has about $30 billion left in its agency debt pot for the remaining five months of the program, it can still buy about half of that net new supply, he said.

Bank of America economist Drew Matus also doubted the Fed is signaling an end to quantitative support, reminding clients the central bank is still in "easing mode."

Instead, some of the Fed's top officials may be throwing a bone to colleagues concerned about the potential inflationary impact of the aid, he said.

"We are not fully convinced this was due to supply concerns but rather may have been a nod to some of the hawks on the committee," Matus said in a research note.

(Additional reporting by Richard Leong and Kristina Cooke)

(For more news on Reuters Money visit http://www.reutersmoney.in)

Inside News

Editor's picks