The Fed Is Killing MBS Market Spreads, Taylor Rule Rudebusch Suggests Fed Funds Target Rate Of 3.25% (It Is 0.25%), Ethereum UP 330% Since Jan 1st

This reminds me of Roberta Flack’s song “Killing Me Softly.” Except it is The Federal Reserve killing the MBS market spreads. And not softly, either

Mortgages ended April with one popular valuation metric at its tightest spread since September of 2012, back when the Federal Reserve announced what would come to be labeled “QE3.”

That name was applied as it was the central bank’s third round of quantitative easing since the collapse of the Great Moderation in 2007. Markets are now on their fourth round of QE — the latest started in March 2020 — which has helped drive the Fannie Mae 30-year current coupon spread over a blend of the 5- and 10- year Treasury yields to 0.60% on Friday.

The Fed statement from September 13, 2012 declared that in addition to $40 billion a month in mortgage-bond purchases, it also expected the federal funds rate to stay at “exceptionally low levels” at least through mid-2015. The bank would go on to purchase $1.4 trillion in agency mortgage bonds through October 2014.

Today, the Fed Chair Jerome Powell has been unmistakably firm that he intends to keep QE4 at its current pace — adding $40 billion MBS per month — at least over the near-term. Consensus is for it to last through year-end. The bank has purchased nearly $2 trillion mortgages so far this round of QE.

So the question that hangs over the mortgage market remains the Fed’s time-line to begin tapering its mortgage purchases. Morgan Stanley analysts noted on Friday that “mortgages are snug on most every metric.” That makes it difficult to argue that they are set to tighten further, even with the central bank holding a heavy supportive thumb on the sector’s valuation scale.

For now, April saw the U.S. MBS index earn 0.11% in excess return over Treasuries. The month of May, historically, has offered average excess return of -0.11% over the last ten years, the third worst compared to all the other months of the year during that time frame.

The Great Modernization? Essentially this means ignoring sensible Federal Reserve guideline like the Taylor Rule which now suggests that The Fed Funds Target rate should be 3.25%, but is being held at 0.25%.

To paraphrase the musical “Cabaret,” volatility makes the trading world around.

Ethereum, the crytpocurrency, is up 330% since January 1, 2021. A sign of the times?

What Inflation? Home Price Growth Almost Doubles After Fed Printing Bonanza, Used Car Prices Up 36%, Lumber Up 149%, Copper Up 43%, Food Up 70%

The way that The Federal government measures inflation shows that there is little impact from the dramatic increase in M2 money supply. US Personal Consumption Expenditure Core Price Index YoY is only at 1.41%.

Yet a number of commodities and housing have increased along with the massive expansion of Federal Reserve M2 money stock. For example, used cars (Manheim US used vehicle value index) has increased 36% since December 31, 2019. Lumber has increased 149% over the same time period and copper has increased 43%. Home price growth has increased to 12% YoY, up from 6.6% for December 2019.

Yet the US Personal Consumption Expenditure Core Price Index YoY is only 1.41%.

Food? Up 70% since March 2019.

Since April, investors are seeking protection in the form of gold and silver.

Of course, there are droughts and weather events that impact food prices. And growing economies can drive up commodity prices. Then again, markets may simply be drunk on Fed money printing.

Fed Leaves Rates Unchanged (Large Wager Placed On Faster-than-expected Pace of Rate Hikes)

Much to no one’s surprise, The Fed has left interest rates at near historic lows.

(Bloomberg) — One large option bet built up over the past week is aiming for a surprise at the Federal Reserve Bank of Kansas City’s annual symposium in Jackson Hole.

While much of the focus this week is on the imminent Federal Open Market Committee decision and Fed Chairman Jerome Powell’s press conference Wednesday, some are looking ahead to the August event in Wyoming, which has often been used by central bankers to signal changes in monetary policy. Last year, Powell unveiled a new policy framework for inflation, while in 2012 Ben Bernanke signaled more bond purchases were on the table.

Ahead of this year’s meeting, a large wager has been placed on a faster-than-expected pace of rate hikes before Sept. 2024, though with an expiry of this coming September.

As it stands, Eurodollar futures imply around five rate hikes, or 125 basis points of tightening by Sept. 2024. The new bet has been entered via risk reversals — where investors buy options which pay off if rates rise but offset the cost by selling those which benefit from a fall — and tops 100,000 contracts, according to traders based in the U.S. who declined to be identified as they aren’t authorized to speak publicly. New positioning was added in the structure over Tuesday’s session, preliminary open interest data from the Chicago Mercantile Exchange show.

It is always a puzzle how The Fed thinks that Q1 GDP growth of almost 8% with an unemployment rate of 6% needs more stimulus.

And the Dow Jones Industrial Average went haywire after the (expected) announcement … then returned to lower than where it was prior to the announcement.