Fed Tapering May See Re-Allocation With Mortgage Backed Securities

cubeU.S. equities are moving slightly higher in early trading on Monday following Friday’s jobs report for May that showed a slightly better than expected 175,000 payroll jobs number combined with the U.S. unemployment rate moving up to 7.6 percent from 7.5 percent in April.

The May jobs report helped to spur a U.S. equities rally over 1 percent on Friday while soothing market fears that the Federal Reserve will soon begin to taper its quantitative easing bond buying program of $85 billion each month.

Fed Chairman Ben Bernanke mentioned in the past that the Fed’s monetary easing program will be aligned with the U.S. unemployment target lowering to 6.5 percent which is now over one full percentage point away.

Sam Stovall, S&P Equity Chief Equity Strategist, said last Friday on Bloomberg’s Street Smart with Regan and Johnson, that the latest payroll data from May which slightly beat the consensus forecast shows an improvement in the fundamentals moving forward.

“Investors are now saying that this market is being driven not by liquidity but by fundamentals and they are very happy to see that the payroll data supported an improvement in the fundamentals moving forward” Stovall said.

Concerning the decision by the Federal Reserve to taper, some leaders in the financial community believe that the numbers from the May jobs report lends more support for the Federal Reserve to begin tapering through a gradual re-allocation of their bond buying purchases which may come as early as September if the U.S. economy continues to improve.

Glenn Schultz, Director of Mortgage Analytics at Performance Trust Capital Partners, said last Friday on Bloomberg’s Street Smart with Regan and Johnson that the jobs report for May doesn’t take the Federal Reserve tapering off the table in any way and if anything else it lends some support for Federal Reserve to begin tapering.

“Remember before QE started, Ben Bernanke gave testimony to the Banking Committee where he said he thought that the Federal Reserve could expand its balance sheet to about 6 trillion before it was disruptive to the market. We are already more than halfway there” he said.

“In the meeting minutes last time the Federal Reserve president and the governors came out and some of them expressed concerns that the Federal Reserve Quantitative Easing (QE) program is disrupting the mortgaged-back securities market. So what I think you would probably see is the Federal Reserve as its first step towards tapering re-allocate its purchases away from mortgaged- back securities and completely into treasuries” Schultz said.

Currently, the Federal Reserve is purchasing  $40 billion in mortgage-backed securities and $45 billion in longer-term Treasury securities.

A gradual shift away from mortgage-backed securities and into Treasury securities would ultimately raise interest rates for U.S. homeowners.

Consequently, the timing of any re-allocation adjustment will be of great importance to the entire housing industry since the housing market has still not yet fully recovered its footing from pre-recession levels and many Americans need the support of low interest rates to afford more home purchases.

The banking industry stands ready to benefit from any tapering or re-allocation with mortgage backed securities.

Thomas Michaud, chief executive officer of Keefe, Byuyett & Woods, spoke on Bloomberg’s Surveillance in late May and weighed in about quantitative easing with its impact on the banking industry.

“QE has been very helpful to the economy but the reality is that near zero interest rates have really been hurting banks at this stage in the game. The industry is not designed to make money at near zero interest rate” Michaud said.

Fiscal Drag

Meanwhile, the fiscal drag on the U.S. economy lingers as “across the board” sequester cuts remain intact on Capitol Hill and the cap on discretionary spending is expected to deepen further in the fiscal year of 2014 by another $19 billion.

Economists are weighing the economic toll that less government spending will take on the U.S. economy amid new cries for infrastructure spending in areas like bridge building and public safety transportation that most Americans believe are vital to its future.

 

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