From MarketWatch - call today to lock your rate 219-762-7200
NEW YORK (MarketWatch) -- Some bond investors are expecting mortgage rates to rise as the Federal Reserve finishes its planned purchases of nearly $1.5 trillion in mortgage-related bonds, yet another risk to the fragile U.S. recovery.
The central bank may address its plans to unwind this program, one of its biggest of forays into the private credit markets over the past year, in Wednesday's policy statement. Read more on the Fed.
"Once we don't have the largest incremental buyer of mortgages, who will step up to take that role?" asked Todd White, a bond portfolio manager at RiverSource Investments.
"It probably won't be a smooth transition, assuming rates are near where we are currently."
Can New Governors Recharge the Stock Market?
Evan Newmark and Dennis Berman debate whether the results of today's elections will send the stock market up.
Since the central bank said nearly a year ago it planned to buy up privately held mortgage-related bonds, eventually becoming the largest buyer of mortgage-backed securities, mortgage rates have tumbled to just over 5% from more than 6%. See related story.
Fed officials and many economists credit the Fed's plans to buy $1.25 trillion in mortgage-backed securities and $200 billion in debt sold by Fannie Mae /quotes/comstock/13*!fnm/quotes/nls/fnm (FNM 1.10, -0.05, -4.34%) , Freddie Mac /quotes/comstock/13*!fre/quotes/nls/fre (FRE 1.20, -0.04, -3.23%) and Ginnie Mae, for weighing on rates. It's already finished the bulk of the purchases, expected to end in March.
Other factors also helped improve dynamics in the mortgage, including a lower supply of new mortgages.
Still, given the size of the Fed's role in this obscure but huge market, which makes up about a third of all U.S. bonds outstanding and takes up a sizable chunk of most bond mutual funds, they are worried that the Fed won't be able to engineer a graceful exit. Any sharp rise in rates could cut off the tenuous recovery in the nation's hard-hit housing market.
"Everyone is sitting there looking at the door," said William Chepolis, who helps manage the DWS Strategic Income Fund /quotes/comstock/10r!kstax (KSTAX 4.56, -0.01, -0.22%) .
"We have a lower position in the mortgage market than we have [had] in two years because I just don't think these prices are sustainable. There will be an upward adjustment there and mortgage will follow."
Even Pimco's Bill Gross has busily sold off his mortgage-related securities after earlier recommending investors buy what the Fed is buying. See Fund Watch.
In its favor, the Fed has already ended one debt-buying program without disrupting the market. Last week, it wrapped up its $300 billion in Treasury purchases. Yields on the benchmark 10-year note barely budged and have hovered near 3.5%, or 45 basis points lower where they were in June.
After last month's meeting, the Federal Open Market Committee said the committee will slow the pace of its mortgage-bond purchases "to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010."
Mind the gap
Mortgage rates, like many other loan products, are usually priced at a certain amount above Treasury securities.
Since the Fed has become the 800-pound gorilla in the mortgage market, the gap between Treasurys and other rates has narrowed sharply, reflecting reduced investor fears about holding mortgage debt compared to safe-haven Treasurys.
The spread between yields on mortgage bonds and Treasurys has fallen to 0.15 percentage points, according to Bank of America's Merrill Lynch unit. That's the lowest since 1998 and way below the long-term average. In December the spread was 1.92 points.