Fed Will Purchase $4.65 Billion 3-7 Year Treasury Coupons Next Week (These Rates Were Made For Dropping)

These rates were made for dropping.

(Bloomberg Intelligence) — The New York Federal Reserve will purchase T-bills twice next week. Besides bills, it will buy the 3-4.5 year and 4.5-7 year coupons using MBS runoff proceeds. In this note, we look at the bonds the Fed is unlikely to purchase, given its self-imposed buying criteria; for T-bills, the Fed avoids those with four weeks or less to maturity. 

The Fed has several criteria for adding bonds to its portfolio. The trading desk will limit System Open Market Account (SOMA) holdings to a maximum of 70% of the total outstanding amount of any security. It also won’t purchase securities trading special in the repo market for specific collateral, newly issued nominal-coupon securities and those that are cheapest to deliver into an active Treasury futures contract. Exclusions also include securities that mature in four weeks or less.

The exhibit shows bonds the Fed likely won’t purchase, based on these conditions.

Screen Shot 2019-10-25 at 11.31.58 AM.png

Here is a snapshot of the 3-7-year sector of Treasury coupons outstanding and their spread relative to a theoretical relative-value spline curve. The Fed will look to purchase securities that are cheap to its own relative-value model.

Screen Shot 2019-10-25 at 11.35.29 AM

The US Treasury curve slope (10Y-3M) has creeped into positive territory.

3m10curve

And mortgage rates continue to rise again.

freddiex

Yes, these rates were made for droppin’. And that’s just what they’ll do.

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