The Fed Stopped Buying MBS Today.

The purpose of the MBS purchases was to suppress mortgage rates and inflate home prices. That process has already begun to reverse itself.

By Wolf Richter by WOLF STREET.

A date for history: Today, September 15, the Fed stopped buying mortgage-backed securities altogether. He had been cutting back on his purchases since the end of last year. Since June, when QT’s phase-in began, it still bought MBS to replace some of the principal payments carried forward from mortgage payments and mortgage payments that reduced its MBS balance. The idea was to keep the MBS liquidation within the limit of 17.5 billion dollars in June, July and August. But this circus is finally over.

In today’s scheduled purchases release, which the New York Fed releases biweekly on Thursdays, there were no MBS purchases scheduled:

The final operation of the Fed in MBS.

Yesterday, September 14, the Fed made its definitive purchase of MBS. The Fed bought $387 million worth of MBS in the To Be Announced (TBA) market, which is a miniscule amount by Fed standards. It went out with a whimper, so to speak.

This is a screenshot of the trade that the New York Fed posted on its website:

Transactions in the TBA market are settled after one to three months. As you can see from the trading information image above, this particular trade will close on October 20th.

The Fed records these trades when they are settled. Therefore, you will book this operation on October 20, which is a Thursday. Their weekly balances are always from Wednesday night and are published on Thursday. This operation will appear in the next balance after October 20, which is the balance that will be published on October 27.

So hallelujah, the balance of October 27 will show the final purchases of MBS. And then it’s over.

A trickle of trades has yet to be settled.

MBS that were purchased in the last two months will continue to appear on the weekly balance sheet until October 27.

This includes a batch of MBS trades that the Fed did on July 25th that were settled on September 14th, and appeared on today’s balance sheet. This is one of the trades that was settled yesterday and included today:

In total, $9.2 billion in MBS trading appeared on today’s balance sheet. It is these operations, when settled, that cause the MBS balance to increase irregularly.

MBS come off the balance sheet primarily through transferred principal payments. When underlying mortgages are paid off because a home is sold or a mortgage is refinanced, or regular mortgage payments are made, the mortgage servicer (such as your bank) sends the principal to the mortgage securitizer (such as Fannie Mae) , which then sends those principal payments to MBS holders (such as the Federal Reserve).

The book value of the MBS is reduced with each payment of capital transferred. This reduces the amount of MBS on the Fed’s balance sheet.

These principal transfer payments are uneven and unpredictable, and do not match TBA market purchases. Therefore, MBS balances form this irregular line of increases when TBA purchases are settled, and decreases when transferred principal payments are eliminated.

The rallies are purchases from one to three months ago, when the Fed was still pricing in QT and still buying MBS to replace capital transfer payments. Downticks are principal payments passed on. Sometimes both coincide and the net movements are smaller:

The last time the Fed did QT from November 2017 to February 2020.

During the latest QT episode, the Federal Reserve phased out MBS from November 2017 to February 2020. The chart below shows this phase of the MBS reduction. During the incorporation phase, about three months passed before the first decreases were recognized. QT back then was much slower, and the initial phase was much longer than the current QT eta.

Notice how the rallies essentially disappeared as the Fed bought less or no MBS to hold the 2nd round cap, and the line softened lower:

Going to zero?

In the future, after October 27, 2022, after the last MBS purchases have appeared, the increases will disappear and the line will smooth out as it descends. But this time, the drop will be steeper and faster.

The Fed has said many times over the years that it wants to get rid of its MBS entirely and only wants Treasuries as assets. So if all goes according to plan, MBS balances will drop to zero. And this could require the Fed to start selling MBS directly later in the process to supplement principal transfer payments. The Fed has already put this option on the table.

The entire MBS episode on the Fed’s balance sheet began in late 2008, when the Fed first started buying MBS as part of QE-1. By the peak in April 2022, the Fed had $2.74 trillion worth of MBS on its balance sheet.

The purpose of the MBS purchases was to suppress mortgage rates and inflate home prices. That process has already begun to reverse itself.

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