This week, the Fed announced new measures to boost the economy. This sounds amazing, and like everything else we have heard in the last two years. So expectations are pretty low for much economic growth to result from the measures taken by the fed. but they did help push mortgage rates to historic lows. The lowest rates we have scene in the last 3 years, not to mention that the rates are bordering on lowest rates we have seen in the last 45 years. You heard it here. We are almost at the lowest rates in history.
The Fed released its statement Wednesday afternoon. The MBS markets then staged a very strong rally for several reasons. The Fed confirmed that there are “significant downside risks” to the US economic outlook. Slower economic growth reduces inflationary pressures, which is favorable for mortgage rates. The Fed then announced the widely expected “Operation Twist program.” A program that will extend the average maturity of the Fed’s portfolio by purchasing $400+ billion of longer-term Treasury Securities and selling an equal amount of shorter-term Treasuries. The third major element from the statement helping mortgage rates was a surprise to most investors. The Fed will begin to reinvest principal payments from its mortgage-backed securities (MBS) holdings in additional agency MBS. Until now, the Fed has been reinvesting the MBS principal payments in Treasury securities.
With roughly $885 billion in MBS holdings in the Fed’s portfolio, these principal payments, along with Operation Twist, will create a significant source of additional demand for MBS. The impact of the announcement was priced in very quickly. Although the Fed has not yet begun to purchase securities under the new programs, investors have already factored in the expected impact of the added demand on MBS prices. Following prior Fed announcements about purchasing MBS, nearly all of the benefit took place right away.