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Mortgage valuation: how much is due to Fed purchases?





This chart from Bloomberg shows the option-adjusted spread (OAS) on current coupon Ginnie Mae MBS, as calculated by Merrill Lynch. Spreads peaked about a year ago, just after the Fed began its quantitative easing program which ended up more than doubling the monetary base. In the context of the widespread belief that Fed purchases of MBS have pulled mortgage rates down to artificially low levels, I would note that the Fed didn't start buying MBS in earnest until mid-March. As this chart shows, mortgage OAS had already declined from a high of 166 bps last November to about 35 bps before the Fed began buying the stuff. Since then, and for the most part, spreads haven't come down all that much further, and have been fairly steady for the past six months. With a negative OAS, mortgages sure aren't cheap, but they've been amazingly stable vis a vis Treasuries for quite some time.

I can't say definitively that the Fed is not keeping mortgage rates at artificially low levels, but that may be a moot point in any event. If rates are going to rise in the future (and I think they will), it will not be because the Fed stops buying MBS, it will be when the Fed and the market realize that policymakers and market participants have mistakenly assumed that inflation risk is extremely low because of the economy's excess capacity (aka slack).

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