MBS spreads to Treasuries
widened again yesterday (1 April), giving those hedging margin calls on TBA shorts a breather. But it is not thought that the US Fed has been frightened off by the MBA’s letter on Sunday admonishing
its actions in the previous week.
Agency MBS spreads have
backed up again, but volatility continues to be the order of the day. Many in the US securitisation market suggest that far from easing dislocation, the US Fed - through its recent actions - has
contributed to it.
The 30-year TBA versus
Treasury spread closed the day at 187bp, while at the beginning of the week it had been as narrow as 125bp, say sources. In mid-February, before the Coronavirus panic gripped the market, it had been
in the region of 95bp.
Spreads in the MBS market
narrowed sharply at the end of last week, as the Fed came in to execute a large-scale buying programme to lower rates in the home loan market. It accomplished this goal, but in doing so left a great
many mortgage lenders facing significant margin calls on hedge positions that were suddenly plunged under water.
The Fed bought US$183bn of
MBS in the week-ending 27 March, to add to the US$68bn it bought in the week-ending 20 March. This two-week purchase of US$250bn represents US$84bn more than the Fed had previously bought in any
four-week period during the financial crisis of 2009.
But what it gave with one
hand it took away with the other. Suddenly, mortgage lenders faced a wave of fresh margin calls which, in some cases, they were struggling to meet.
Mortgage lenders typically
short the TBA market forward before they sell new mortgage loans to the GSEs, in order to offset any losses that would accrue from rates trending higher. If rates do increase before they can sell the
loan to Fannie Mae and Freddie Mac, they buy back the hedge at a profit which covers the loss.
Moreover, lenders often put
on naked shorts, inasmuch as they have not yet acquired the loan let alone sold it to the agencies. Lenders will also usually aggregate loans before they pass them on and, in the current period of
dislocation, this process is taking longer. Consequently, the lender is holding a naked short for a more extended period than is usual.
As rates suddenly dipped at
the end of last week, lenders were forced to meet margin calls for the hedges that were suddenly and unexpectedly under water. “According to TBA guidelines, you have to post margin. So, when rates go
down and bond values go up, you have to post margin because your short just got bigger. So, when the Fed comes in and artificially pushes it up, you lose, if you’re holding a naked short,” explains a
At the same time, the
actual sourcing of paper to deliver into a short becomes more difficult, as the Fed has hoovered up so much. The Fed is also often the buyer of the short position as well.
“There are various ways to
satisfy a short, but in this case, every way has become more expensive,” the consultant adds.
Fed action at the end of
last week elicited a vigorous response from the Mortgage Bankers Association (MBA). On Sunday it sent a letter to the Fed, claiming the US housing market is “in danger of large-scale disruption”,
thanks to its intercession.
The MBA declined to comment
in detail about its response, but instead pointed SCI to the letter it sent to explain its action. The letter went on to say: “The dramatic price volatility in the market for agency MBS over the past
week is leading to broker-dealer margin calls on mortgage lenders’ hedge positions that are unsustainable for many such lenders.”
The fact that yields in the
MBS market moved back out yesterday prompted some observers to speculate that the Fed had got the message and backed off. Others thought this less likely. Certainly, the Fed has not made any
announcement on these lines.
Indeed, the spread widening
is more likely due to the fact it was not part of a buying cycle by the Fed, and also because Treasuries rallied strongly as part of a risk-off trade as stocks plummeted once more.
The Fed’s actions across
markets have aroused dissension from a number of quarters. In taking action in one area of the market, it has often not helped another, thanks to the law of unintended consequences.
In particular, Minneapolis
Fed president Neel Kashkari’s 22 March comments on the widely-viewed and respected CBS current affairs show 60 Minutes excited particular disfavour.
Extolling the Fed’s ability to spend out of the current cataclysmic collapse in market values, Kashkari said: "We're far from out of ammunition.... There's an infinite amount of cash at the
These comments were greeted
with ill-concealed incredulity by many on the Street. “It was completely inappropriate to suggest that what the government can do is unlimited. It isn’t. There are theoretical and physical limits to
what they can do,” says one.