Why the Fed's actions may only go so far to support mortgages

Federal Reserve officials are likely to keep limiting their mortgage-backed securities activity to runoff the way the industry would like, but that won't necessarily narrow spreads to Treasuries that have contributed to the rate volatility the way trade groups hope it will.

That was the take a panel of industry experts had on Fed policy during Information Management Network's Mortgage Servicing Rights conference on Friday.

"I think the spreads for general purposes have to come down and they are really not going to until people are certain the Fed is done," said Scott Tweedy, vice president of capital markets administration at Pulte Mortgage, referring to officials' tightening of short-term rates.

While some voices within the industry have called for the Fed or government-related mortgage investors Fannie Mae and Freddie Mac to buy MBS to address rate volatility, panelists don't see such actions as currently aligned with policymakers' interests.

The Fed ultimately "wants to get back to a balance sheet that's predominantly Treasuries," Conrad DeQuadros, senior economic advisor, Brean Capital said during the panel discussion.

The Fed might have been more aggressive and sold MBS if it hadn't been for the banking crisis in March, he said. That crisis highlighted the fact that sales of older, lower-coupon bonds could result in losses and the Fed has many of those on its balance sheet.

While the Fed doesn't have the same pressures related to capital requirements and other regulations that banks do, there are accounting implications related to aggressive MBS sales that would be unfavorable, DeQuadros said.

As long as policymakers feel the need to cool inflation, they're unlikely to buy MBS. Only home inventory constraints relative to demand have kept their actions and related goals from exerting more downward pressure on the residential market.

"The Fed tried to crash the housing market but low supply effectively reversed it," Nik Shaw, Home LLC's CEO and moderator of the panel, quipped, giving his take on the group's consensus view.

While the supply side is somewhat immune to pressure from the Fed, there is a point at which it could have an impact given that builders have been offering rate concessions to address affordability concerns. If rates were to rise high enough, those concessions could hurt profit.

At that point, "in order for builders to protect their gross margin, they'll slow down production," Tweedy said.

Forecasts generally continue to maintain that a recession might be possible next year, which would make lower or stable rates more likely than higher ones, although panelists noted that previous projections calling for such an economic shift earlier have been wrong.

Policymakers might consider buying MBS in a situation where there was a broad downturn, but while there are some credit concerns starting to materialize in the mortgage market they're not on that order of magnitude, panelists said.

"The only thing that's lowered rates is a weak economy," said Tweedy, noting that upticks in delinquencies seen to date on Federal Housing Administration-insured loans and credit cards don't equate to that kind of stress.

But some panelists said they agree with a recent consensus seen among some in the market that the Fed could be at or near the end of its tightening cycle.

"I think we're at a transition point, literally this month, where we'll start to see the fruits of the Fed hikes," said Vince Zenner, senior vice president of portfolio management at Guaranteed Rate.

In the long-term, there may be a 40% probability the economy has a soft landing where it weakens without undue shocks, and a 60% likelihood of a "boil the frog" scenario, said Nicholas Maciunas, head of agency MBS research, JP Morgan, citing a forecast his company's had.

In the latter scenario, "something's eventually going to break in the housing market, but it's going to be felt slowly," he said.