The Federal Reserve could stop increasing its holdings of mortgage-backed securities (MBS) several months before it finishes increasing its inventory of Treasuries, if the findings of a Reuters poll of economists are any guide . Read more
The expectation that the US central bank will cut its purchases of MBS by a relatively greater proportion than its purchases of treasury bills coincides with a growing debate about the need for any purchase of home-backed assets, given the real estate market. boiling.
It’s unclear exactly how the Fed will go about slowing the expansion of its $ 8 trillion balance sheet, an asset pool that has roughly doubled since it started large-scale purchases in March 2020 to stem the massive economic fallout triggered by the Covid19 pandemic.
The Fed cut its benchmark short-term interest rate to near zero at the start of the pandemic, and bond purchases were also designed to help anchor long-term rates, keeping costs down. borrowing for households and businesses.
The results of the Reuters survey, which were released on Friday, showed economists expect the Fed to unveil its plans to cut its monthly purchases of $ 80 billion in treasury bills and $ 40 billion. of MBS in the third trimester, perhaps upon his annual withdrawal from his policy. in August.
Moreover, the poll showed that the median view of economists indicated that the Fed would reduce its purchases of Treasuries and MBS at an initial rate of $ 10 billion each, likely from January 2022. That would represent a 12.5% reduction in treasury bill purchases but a 25% reduction in MBS purchases.
If the central bank’s previous debt reduction exercise in 2014 serves as a model, that pace would signal the end of its MBS reduction by the middle of next year, with additions to its Treasury holdings ending closer. by the end of 2022.
SUPPORT AGAINST HOUSING?
Reducing asset purchases is a critical first step in the eventual normalization of monetary policy and one that Fed officials should start discussing as early as next week, when they meet for a two-day meeting, so that the economy is showing signs of recovery. rapidly from its pandemic-induced recession.
The Fed’s initial mission in March 2020 was to restore order to financial markets that were sinking at the onset of the crisis, and its massive purchases of Treasuries and MBS backed by Fannie Mae, Freddie Mac and Ginnie Mae – among the most widely owned and trusted government-backed assets in the world – have helped achieve this.
More recently, however, some Fed policymakers have questioned the need to track MBS purchases, especially given the different role they played in this crisis. Dallas Fed Chairman Robert Kaplan and Boston Fed Chairman Eric Rosengren noted that the housing market – the trigger for the financial crisis more than a decade ago – is in full swing. boom and hardly lost a step during the pandemic.
And Kaplan, for his part, said he believed the Fed’s purchases of MBS could have the unintended side effect of fueling the excesses.
Bill English, who as the great Fed economist helped shape the Last Tap, isn’t buying it.
“Declining faster with MBS is a way to lean a bit on what might be considered risks in the housing market. That would surprise me, ”English, now a professor at the Yale School of Management, said at a Deutsche Bank event this week. He noted that housing market excesses were not due to the kind of leverage seen as the 2007-2008 financial crisis approached, and that shifting purchases from MBS to Treasury bills would not have been the case. only a small effect on mortgage rates because the housing market primarily prices off of Treasury yields anyway.
“It’s just a marginal effect,” English said. “Nonetheless, we can see a discussion about it.”
In the latest cut, the Fed slashed its purchases of the two assets by $ 5 billion each in the month following each policy meeting after it unveiled its plan at its December 2013 meeting. Officials insisted that the reductions were not on a predefined trajectory, but they never deviated from this script once and ended the reduction program at the end of October 2014.
Then, however, the Fed had bought $ 45 billion in Treasuries and $ 40 billion in MBS each month during its final round of quantitative easing, known as QE3. The Fed now buys twice as many Treasuries each month as MBSs, so reducing the pace by the same amount on each front would close the reduction in MBS significantly faster.
Indeed, some Reuters poll respondents predicted a pace for each that would reflect the current allocation and end the decline in assets at the same time. Others suggest that it can start with a modest MBS cone only.
The position MBS holds in the Fed portfolio and the central bank’s footprint in that market, however, add a different wrinkle this time around.
Given the importance of MBS for the mission after the financial crisis – supporting a slow-to-heal housing market – mortgage bonds then represented a significantly larger share of the Fed’s total bond holdings – over 40% – than they are now – around 30%. And the Fed’s share of the MBS market was also larger, peaking at nearly 30%, than in the current program, when it held less than a quarter of the market earlier this year.
In contrast, the Fed’s footprint on the Treasury market, around 25%, is larger than during its previous asset purchase program.
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