If this 3.9% yield results in dissatisfaction for those risk taking investors, then it may mean a rotation to equities and/or higher risk assets.

TO BE NOTED: From EconomPic Data:

"High Quality Credit Risk vs. Duration Risk

As the yield on the 30 Year Treasury has spiked in recent months from a low of 2.5% all the way up to 4.3%, the yield to worst on the Barclays Aggregate Bond Index (i.e. formerly the Lehman Brothers Aggregate Bond Index - a blend of intermediate bonds made up by ~1/3 Agency Mortgage Bonds, ~1/3 Treasuries, ~1/3 Investment Grade Corporate Bonds) has tightened to 3.9% from over 5.5% as recently as October.



In other words, the appetite for "high quality spread" has increased relative to duration (i.e. interest rate) risk, thus bringing down the required return of intermediate bonds relative to the 30 year Treasury. If this 3.9% yield results in dissatisfaction for those risk taking investors, then it may mean a rotation to equities and/or higher risk assets.

While I personally am still vehemently opposed to investing in equities at this time (I can't look at the fundamentals of the economy in its current state and put my money at risk at the bottom of the capital structure REGARDLESS of valuation), the chart below tells a different story. The chart shows the difference between the 30 Year Treasury Bond's yield and the yield to worst for the Aggregate Bond Index, against the one year forward return on the S&P 500 and we do see a relationship.



When the spread turned negative (i.e. investors were less worried about duration risk, then taking on spread risk) it looks like equities underperformed in the ensuing 12 months, possibly as institutional investors reallocated from equities to greater yielding credit. On the other hand when the spread turned positive (such as today), investors became increasingly worried about duration risk and moved to equities.

There is, as always, a "this time is different" caveat. Much of the reason for this high quality spread tightening has been technical in nature as the Fed and Treasury continue to throw money at all the economy's problems. Both Agency MBS (the Fed is actively buying mortgages) and Investment Grade Bonds (think TARP injections to financials) have benefitted by this money at the margin.

And all that money comes at a cost... new Treasury sales and higher Treasury yields.

Posted by Jake"

asset purchase programs (MBS and Treasuries) more like insurance against rising real rates than true stimulus in the housing market

TO BE NOTED: From News N Economics:

"Asset purchase programs Update

Thursday, April 23, 2009

The Fed has been busy these last few weeks, acquiring its promised agency MBS in large quantities and jumpstarting its Treasury purchase program. By my calculations, total government asset accumulation totals $572 billion to date.

• The Fed purchased $381 billion in agency MBS at roughly $30 billion a week (since the announcement to purchase an extra $750 billion in agency-backed MBS on March 18). At this rate, the Fed will buy the announced $1.25 trillion by December 2009.
• The Fed acquired $65.2 billion in Treasuries bonds and notes, and $1.5 billion in TIPS since March. The Fed is buying the full length of the yield curve, maturity dates from 2009-2039. Interestingly, the Fed purchased TIPS last week. To me, further acquisition of TIPS would signal the Fed’s upward inflation bias – pulling out later than earlier.
• The Treasury continues its smaller but still active MBS purchase program, holding $124.3 billion as of March 2009. The Treasury’s flow of MBS is reported only monthly and at a lag, so it may be holding more.

The Fed and Treasury efforts are translating into lower mortgage rates; the 30-yr conventional mortgage rate fell 0.43% to 4.82% since February. However, the downward momentum was discrete, occurring fully in the wake of the Fed’s announcement to buy Treasuries. Furthermore, prices fell 0.1% in March, offsetting some of the downward momentum on real mortgage rates. Price declines are likely to catch up and even surpass nominal mortgage declines, leaving real mortgage rates unchanged, perhaps even up.

In reality, the deflationary (disinflationary) scenario that is typical of a recession of this magnitude makes the > $1.55 trillion Fed and Treasury asset purchase programs (MBS and Treasuries) more like insurance against rising real rates than true stimulus in the housing market, and fiscal measures are key. It seems that the fiscal stimulus will provide a floor under the economy, so that with stable real mortgage rates and record price declines, home sales have a real chance of bottoming in a few months, if they have not already.

Rebecca Wilder"

Federal Reserve Bank of New York said late Thursday it had purchased another $47.3 billion in agency mortgage-backed securities this week

TO BE NOTED: From HousingWire:

"The Federal Reserve Bank of New York said late Thursday it had purchased another $47.3 billion in agency mortgage-backed securities this week from government-sponsored entities Freddie Mac ([1] FRE: 0.80 -4.76%), Fannie Mae ([2] FNM: 0.72 -2.70%) and Ginnie Mae. For the week ending March 25, the Fed purchased, net of $14.1 billion in coupon sales, $33.2 in agency MBS.

The Fed bought $13.45 billion from Freddie’s books, $32.55 billion from Fannie and $1.25 billion off Ginnie’s books this week. Thirty-year 4 percent coupons were the most popular item purchased at $19.7 billion from all agencies, followed by 30-year 4.5s at $12.5 billion. Meanwhile, the Fed also sold $14.1 billion in Fannie’s coupons. Thirty-year 5.5s sold the most, at $7.25 billion, while 6s sold $4.7 billion and 5s sold $2.15 billion. It was the fourth consecutive week of listed sales. All told, the Fed’s purchases have grossed $355.15 billion so far, but net of sales that figure drops to $341.55 billion.

[3] See a detailed table of the current week’s purchases and sales.

The Fed’s assets gained $9.56 billion the same week ending March 25, according to a balance sheet summary released Thursday. The data show the Fed’s consolidated balance sheet grew to a value of $2.05 trillion, and is up $1.18 trillion from the year-ago week ended March 26, 2008. Last week, the Federal Open Market Committee released a statement announcing it had decided to [4] increase the Fed’s balance sheet in an attempt to “provide greater support to mortgage lending and housing markets….” The FOMC said it would increase the Fed’s purchases of agency MBS by $750 billion, to $1.25 trillion this year. It also announced it would increase the Fed’s commitment to purchase agency debt by $100 billion, to a total of up to $200 billion.

Write to Diana Golobay at [5] diana.golobay@housingwire.com."

Purchases in agency MBS by investment managers acting as agents for the System Open Market Account (SOMA). Purchases summarize all trades executed during the indicated period including purchases associated with dollar rolls. Purchases executed during this period and prior periods, which have settled, will be reported on H.4.1: Factors Affecting Reserve Balances
E-mail alert

Gross purchases from March 19 through March 25: $47,250 million Net purchases from March 19 through March 25: $33,150 million All amounts reflect current face.

Purchases Sales

	Purchases ($ million)
Maturity 30 Year	Coupon FHLMC FNMA GNMA 4 10,100 9,300 250 4.5 3,250 8,250 1,000 5 2,150 5.5 7,250 6 4,700
15 Year1	4 100 900
Other2
Total	13,450 32,550 1,250

1 Inclusive of 10 year product. 2 20 year, 40 year and other agency programs.

"In sum, these firms just got hired to use the public’s money to buy assets from themselves."

A couple of posts focus on the Conflict Of Interest inherent in the Fed's MBS Purchase Program and the four named firms. First, Mr. Mortgage:

"MBS - The Fed (tax payer) Has to Bailout Foreign Central Banks

Posted on January 2nd, 2009 in Daily Mortgage/Housing News - The Real Story, Mr Mortgage's Personal Opinions/Research

“….over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant.”

I don’t think this recent move has to do as much about lower mortgage rates for you and me rather Foreign Central Banks and the likes of Bill Gross being in a panic over their holdings( HERE WE GO ). Before this announcement in early December, MBS were not performing well with all-time historic wide spreads over longer dated Treasuries.

As a matter of fact, there is a good chance rates do not come down to the levels being forecast. After nearly a month of constant headlines about the Fed buying Agency MBS, a 30-year fixed today is still around 5.25% at 1 point vs 5.75% prior. A few days in the past month we saw sharp dips down under the 5% level, but that market action was fleeting lasting one or two days and rates quickly shot back up.

Foreign Central Banks have been in the US mortgage market for a long time and arguably did not know what a mess the GSE’s and their lending practices were. Bill Gross, the largest holder of Agency debt outside of the FCB’s, admittedly bought a large portion of his present position front running the Fed knowing full well the risks in owning mortgage-related debt. Until the Fed made its recent announcement, all Agency debt owners were feeling a tremendous amount of pain, as MBS’ had been kicked to the curb in favor of UST. Wars have been waged for much less than seeding an FCB’s balance sheet with hundreds of billions in toxic securities.

Drastic times call for drastic measures and printing, in order to buy MBS, was a real ‘Hail Mary’ move. But I suppose it had to be done given that at the end of November, the mortgage scene was looking bleak. 10-year Treasures were holding below 4%, the short had been bid to zero and mortgage rates were rising as the government refused (and still does) to issue that illusive ‘explicit’ guaranty. Currently, with the GSE’s in conservatorship Agency MBS have an ‘effective’ guaranty.

It is no doubt that the FCB’s, with the global crisis reaching deep into their balance sheet’s as well, were not too thrilled about owning relatively illiquid GSE mortgage debt without a ‘Full Faith and Credit’ backing( IMPLICIT GUARANTEE. NO. THEY WEREN'T ). Especially considering how the sector worsens monthly as home prices tumble, defaults surge and the nation is in the midst of one of the nastiest recessions ever. To top it off the solons (ex-Ben) that created all of the ‘plans’ leave office and the fate of the GSE’s and the paper they back is anybody’s guess. Adding another $5 trillion in mortgage guarantees on top of the near $9 trillion in existing backing could do some real damage to the US sovereign debt rating.

GSE MBS used to be relatively liquid with predicable durations. But now with values down creating epidemic negative-equity across America, defaults surging and unemployment rising, nobody has any clue how long these loans/MBS will be on balance sheet. Very few home owners keep a loan for 30-years that’s for sure. If they don’t or can’t refi then death, disease, job-loss etc will get them over time. Very few MBS holders likely ever thought they would be in their positions as long as many presently even have. I can promise you that China and Russia do not want to be landlords of a bunch of over-leveraged, unemployed American’s.

Who would want a bunch of Agency MBS after everything that is now known about all of their Alt-A and Subprime holdings, terrible risk management and massive house price depreciation that results in significant losses every time a loan is foreclosed upon? ‘Face value’ surely doesn’t mean what it used to now that the collateral underlying the securities is down 25% to 75% over the past 18-months depending upon where the properties are located. Most Agency MBS in existence today are time bombs( NOT ACCORDING TO WILLIAM GROSS ).

Foreign Central Banks Pare Agency Debt –Uncertainty May Cloud Fannie, Freddie Note Sales in First Week of New Year — By PRABHA NATARAJAN

In a sign of the uncertainty weighing on mortgage companies Fannie Mae and Freddie Mac, foreign central banks continued to trim holdings of U.S. mortgage-related debt( NOT GUARANTEED ).

This comes as the two nationalized firms, which together account for about half of the $12 trillion U.S. home-loan market, are slated to sell debt issues in the first week of 2009.

Data from the Federal Reserve Bank of New York published Monday show foreign-central-bank holdings of debt related to the mortgage companies, including debt sold by the Federal Home Loan Bank system, stood at about $819 billion on Dec. 24, down from $833 billion on Dec. 17.

Foreign-central-bank holdings of this debt, which includes bonds sold directly by the firms and mortgage-backed securities they guarantee, reached a peak of nearly $986 billion in mid-July, after the Treasury first asked for the authority to extend its credit lines to these firms. Click link above for more…

So, what is the most efficient way to help our FCB buddies sell their trash MBS? Right…get the US taxpayer to buy it. Print money( THIS IS WHAT I THINK THAT THEY WERE SAYING THEY WOULDN'T DO IN THAT ODD BIT OF CIRCULAR REASONING. ) and put a bid under MBS for the next year with announcements and selective buying of $5 billion here and there whenever the market gets weak. Then the FCB’s and Gross can sell into artificial strength and buy US Treasuries with an explicit guaranty( THAT'S THE PLAN. ).

“Purchases will be financed through the creation of additional bank reserves.”

“The goal of the program is to provide support to mortgage and housing markets and to foster improved conditions in financial markets more generally.”

“The New York Fed will adjust the pace of its purchases based on input from the investment managers about market conditions and the impact of the program. The investment managers will be required to purchase securities frequently and to disclose the Federal Reserve as principal.”

Maybe PIMCO, as one of the four chosen investment manager and largest owners of GSE MBS, can start paying its dividend on all of its funds again soon. If this is not ‘the fox in charge of the hen house’ I do not know what is.( THERE IS NO WAY TO WRING THIS PROBLEM OUT OF THIS PLAN. THE SOCIAL IMPLICATIONS OF CRONYISM AND COLLUSION ARE A REAL PROBLEM. )

On a higher level, this approach could kill all sorts of birds with one stone unless the parties involved don’t follow through with the Treasury buying plan and decide to sell those into strength too. That could put the US in a position where the Fed is the lender of last resort printing money like crazy to buy everything ( THAT IS A GUARANTEE, HOWEVER )— that would be bad news…Doh!

If this is indeed the plan, the big question going forward is if the buy pressure from the Fed and all of the lemmings chasing the Fed is enough to offset the sell pressure from the Foreign Central Banks. If buy and sell pressure are about equal, obviously MBS and rates tread water. If not and people smarten up to what is really happening and panic out of MBS, then rates go up quickly( INFLATION ). That is of course unless the Fed cranks up the tax payer printing press and buys more they announced, which is a highly probably outcome( STILL INFLATION ).

After nearly two-years of misinformation and games why don’t they just be honest this time around…( THAT IS ESSENTIAL, AND IT IS A CORNERSTONE OF BAGEHOT'S PRINCIPLES. )

To ensure the system stays together, wars are not waged and mortgage rates don’t shoot to 20%, the US taxpayer is being called upon to clear the balance sheets of Foreign Central Banks and investors( YES ). These parties which did not understand that there was never an ‘explicit’ guaranty( THERE WAS AN IMPLICIT GUARANTEE, AND IT HAS NOW COME DUE MY FRIEND. ) and trusted that what we were selling were not balance sheet nuclear bombs are needed this minute to fund our book.-Best Mr Mortgage

Another look at this from my buddy Rolfe at Option Armageddon: Self-Bailouts: Nice Work if you can get it"

From Option Armageddon:

"Nice work, if you can get it

December 31, 2008 – 1:28 am

The Federal Reserve will print money to buy $500 billion worth of mortgage-backed securities by June, specifically MBS issued by Fannie, Freddie and their sister Ginnie Mae. And guess who the Fed has hired to manage the purchases? PIMCO, Goldman, BlackRock and Wellington.( IT'S IMPORTANT TO UNDERSTAND THAT IS SIMPLY ANOTHER FORM OF TARP BUYING TOXIC ASSETS. THE THEORY IS THAT THESE MBSs WILL BE BOUGHT HERE IN A DOWNTURN, AND SOLD IN THE FUTURE FOR A PROFIT, AND CHEAPLY FINANCED BY THE FED. SAME THEORY AS THE ORIGINAL TARP PLAN. )

This is quite a scam for all of them, especially PIMCO( SAME CONFLICT OF INTEREST PROBLEM AS WE TALKED ABOUT WITH TARP. ONLY NOW, WE NEED TO KNOW HOW PIMCO MADE OUT IN THE GMAC DEAL AS WELL. ). The ultimate self-bailout you might call it. As of June 30th, 61% of the PIMCO’s assets were invested in MBS. $500 billion in total. No doubt the others also own a pile of Fannie/Freddie/Ginnie bonds.

In sum, these firms just got hired to use the public’s money to buy assets from themselves.

Is it any wonder why PIMCO chief Bill Gross argued so vociferously for Treasury to start buying troubled assets? In a much publicized investor letter on Sept 4th, he said the following:

If we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the U.S. Treasury.

To be fair, he wasn’t wrong. A “debt liquidation of historic proportions” is indeed what would have happened had the Fed and Treasury not stepped in( I AGREE ). And that would have crippled the world economy. But Gross, the largest bond fund manager on the planet, may have been hardest hit of all.( I AM, AND REMAIN, A WILLIAM GROSS FAN. BUT AS I SAID EARLIER ABOUT TARP, I'M NOT SURE THAT I CAN EVEN TRUST WILLIAM GROSS IN THIS SITUATION. )

Once upon a time, the Chinese owned hundreds of billions worth of MBS themselves, as did the Russians. But when Fan and Fred collapsed, the foreigners skedaddled( FROM IMPLICIT TO EXPLICIT GUARANTEES. WHAT DOES THAT TELL YOU? ). Can you blame them? They had invested their people’s hard-earned savings in piles of Fannie and Freddie debt which, save for a U.S. Treasury guarantee, would have fallen precipitously in value. Now the government has to make good on that guarantee( THAT'S RIGHT. THE IMPLICIT GUARANTEE HAS BECOME EXPLICIT. ), buying up all these MBS that no one else wants.

The Fed argues this will boost housing by lowering mortgage interest rates. In reality, lower rates may actually “spur a new wave of defaults.”( COULD BE )

By the way, the Fed will “monitor” each firm to avoid conflicts of interest( THE MAIN PROBLEM, AND IT CAN'T BE AVOIDED IF THIS PLAN IS USED. ):

Each investment manager will be required to implement ethical walls that appropriately segregate the investment management team that implements the Federal Reserve’s agency MBS program from other advisory and proprietary trading activities of the firm. The New York Fed will monitor each investment manager’s compliance with this requirement.

Good thing we have “ethical walls” to protect taxpayers."

We do have walls around the Torah, according to Pirke Avot. Anyway, you can see that this Conflict Of Interest is going to be an important issue going forward. That's why I think that this plan is a mistake. It has a large Social as well as Economic downside. I do hope it works, however, if we do it.