Fed Purchase Of Mortgage Bonds Spurs Others

The Federal Reserve kicked off its program to buy $500 billion of mortgage bonds guaranteed by Fannie Mae (FNM), Freddie Mac (FRE) and Ginnie Mae on Monday, causing risk premiums that influence mortgage rates to narrow. The central bank’s program, together with the U.S. Treasury’s more than $50 billion worth of purchases to date, have already encouraged big banks to buy these bonds backed by home loans extended to consumers with solid credit histories.

Together, these measures should strengthen the mortgage market and rekindle buying of these bonds by other investors like foreign central banks that abandoned the market last year. The 30-year fixed-rate conforming mortgage, currently at 5.3%, is expected to eventually drop to 4.5% as a result of the government’s intervention, market strategists predict.

The Fed’s purchase of half a trillion dollars of mortgage bonds will cover almost an entire year’s worth of new supply of these bonds.

Higher demand for these bonds shrinks the risk premiums, or the difference in yields of these bonds and comparable Treasury bonds. The lower costs to bond issuers is passed on to consumers as lower interest rates.

The Fed will announce how many mortgage bonds it will purchase through Jan. 7 on Thursday.

The Fed’s purchases starting Monday spurred buying of agency mortgage bonds by money managers, causing risk premiums to narrow 7 basis points to 193 basis points over comparable Treasury yields, early afternoon. Art Frank, a mortgage strategist with Deutsche Bank, said the buying wave had started last Friday as banks readied for the Fed’s action. “The dealer community had anticipated that the Fed would start buying this week, and many of them had started buying on Friday,” he said.