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Fed's MBS purchase program ending with a yawn

The Fed's program to purchase $1.25 trillion of MBS will end in a few weeks, but for all intents and purposes, and as far as the market is concerned, it is over. The big question all along has been how much these purchases, which began about one year ago, were distorting the market, and therefore how disruptive the end of the program might be.

A quick glance at the top chart here would suggest that the Fed's purchases have played a significant role in bringing down mortgage rates and thereby supporting the housing market; fixed rates on jumbo mortgages have fallen 235 bps since the program was announced on Nov. 25, 2008, and conforming rates have fallen about 125 bps.

But since the Fed has only been purchasing conforming MBS, that doesn't explain the outsized decline in jumbo rates, and the huge narrowing of the spread between jumbo and conforming rates. If the Fed were artificially supporting the prices of conforming MBS, then the spread between conforming and jumbos should have widened, not tightened.

Spreads on conforming mortgages have fallen to their lowest levels ever, as shown in the second chart. Could this be all due to Fed purchases? I tend to doubt it. If the Fed were artificially supporting the market, then the proximity of the end of the support should have already caused the market to push spreads wider, but there's no sign of that yet. Yes, spreads have widened just a bit in the past several days, but that's no more than just a random blip.

I've argued in the past that the end of the Fed MBS purchase program could result in a 30-50 bps widening in MBS spreads. That's still possible, but right now it seems less likely. The explanation for why spreads are so tight is therefore this: spreads are tight because the market expects Treasury yields to be relatively low and stable for a long time, and MBS are therefore very attractive since they offer higher yields with virtually no default risk.

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