The strain imposed on financial markets last month resulting from the COVID-19 pandemic has hit virtually every asset class and sector, including agency mortgage-backed securities (MBS). The fast pace, sizeable decline in risk assets and widening in spread products have forced many accounts to liquidate assets to raise cash at depressed and volatile prices in order to meet margin calls and redemptions. In response, the Federal Reserve (Fed) quickly and aggressively acted to implement a number of measures, including its fourth round of quantitative easing (QE4). On March 15, the Fed announced that “over the coming months,” it would purchase $500 billion and $200 billion of U.S. Treasuries and agency MBS, respectively, “to smooth the functioning of markets,” beginning the next day.
After prices continued to fall and volatility increased over the next week, the Fed expanded its support by announcing March 23 that it would “increase holdings of Treasury and agency mortgage-backed securities...in the amounts needed to support the smooth functioning of markets…and will begin agency commercial mortgage-backed security purchases this week.”
This week’s chart shows the size of Fed purchases and option-adjusted spreads (OAS) of agency MBS. The size of the Fed’s purchases combined with a slowdown in forced selling and deleveraging has currently stabilized agency MBS spreads. In other areas of residential mortgage-backed securities (RMBS) not supported by the Fed, particularly non-agency MBS, spreads have recovered slightly from the initial shakeout in mid-March but remain much wider than pre-pandemic levels. Meanwhile, non-agency new issuance has come to a halt.
Key Takeaway
The Fed has used lessons learned from the global financial crisis of 2008-2009 and stepped in quickly and forcefully, with hopes of preventing the current health and economic crisis from developing into another financial crisis as well. The size of the Fed's purchases in agency MBS, including over $100 billion in short (T+2 or T+3) settlements to assist cash-needy investors, is evidence of our central bank’s willingness to do “whatever it takes” to help ensure the proper functioning of credit markets and lower borrowing costs for home buyers.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice. The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete. Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements. Actual results may differ significantly. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.
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