Big Boys Buying Mortgages In Reaction to Treasury Plan

Big Boy Investors like PIMCO, TCW, and Fifth Third Asset Management are buying mortgage backed securities and favoring them over treasuries.

A March 23 Ried, Thunberg & Co. survey said fund managers overseeing $1.19 trillion cut their government securities holdings to the least this year while they increased mortgage assets.

This is in reaction to the Federal Reserves March 18 plan to buy Treasuries and $750 billion of mortgage-backed securities from Fannie Mae, Freddie Mac and Ginnie Mae.

So far the plan which is designed to lower consumer interest rates by taking supply out of the market seems to be working. A contrarian might ask? Is this front running or the makings of a trend that can be sustained over a long period of time?

Interest rate spreads are clearly narrowing across most quality preferences. The spread between the ten year Treasury and Fannie Mae’s current-coupon 30- year fixed-rate narrowed to 118 basis points last week, down from 232 basis points in November. The spread on industrial corporates narrowed from 557 basis points to 468 basis point since the announcement.

These narrowing in the interest rate spreads can also be seen as a vote of confidence for the recently announced Fed plan.

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Will the Fed Try to 'Rig' the Long Term Treasury Market?

It appears that Fed policy makers are exploring the purchase of longer-dated Treasury securities in an effort to push up their price and bring down their yield. This reminded me immediately of the Treasuries effort to manipulate the price of gold in the late 1970s. In an attempt to do this, the Treasury started periodic sales of gold. As I recall, they started selling gold into the market around $175 an ounce. They finally gave up when gold reached well into the $400s. They sold not a single ounce as gold soared up and over $800. My point here is simple--you cannot 'rig' the markets no matter how hard you try. Eventually the rubber band breaks and most times the resulting equal and opposite reaction is chaos.

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My guess is that the only thing the Fed will accomplish is to bring wild and crazy swings into the Treasury market. In other words, volatility. In the late 1970s and early 80s it was not unusual to see the long bonds move 2 or more points in a day. The daily trading ranges often exceeded 3 points. Around the same time it was not unusual to see short term rates, treasury bills, move in trading ranges greater than one percent a week. So far interest rates have been relatively tame.

It seems that nothing much changes. The "new new" thing here is to use taxpayer money or federal balance sheet leverage to cure the "sick patient". Will this work, I doubt it. My guess is we take our medicine and eventually things smooth out and then we get on a rehab program. All of this takes time. There are no overnight solutions. You can take your three antibiotic pills a day for ten days and soon enough you will be feeling better. But guess what, if you take all 30 in a single day they won't work and worse, you'll suffer from a very nasty and negative reaction.

It should be apparent that Federal regulators are running out of bullets. My suggestion is we get these guys into the Economics 101 course to revisit the laws of supply and demand. In my opinion, understanding the supply/demand equation is the real long term answer to our current economic woes.

Bernanke Risks ‘Very Unstable’ Market as He Weighs Buying Bonds