US mortgage rates have risen to the highest level in months despite recent Federal Reserve interest rate cuts, complicating the central bank’s efforts to stimulate the US economy as the spread of coronavirus curtails business activity.
The costs to consumers are increasing because of logjam in the $7.5tn market for mortgage-backed securities (MBS), where most US home loans are bundled into securities guaranteed by Fannie Mae and Freddie Mac, the government-controlled “agencies,” and sold at yields that tend to track those on the 10-year Treasury note.
As the Fed has lowered rates in recent weeks, consumers have rushed to refinance mortgages, flooding the market with MBS. However, as the coronavirus has spread, banks and brokers that act as intermediaries in the market have struggled to sell the bonds. They also have little appetite for adding more of them to their balance sheets
“Liquidity in mortgage-backed securities market, which is usually the second-most liquid market in the world after Treasuries, is on par with, if not worse than, what we saw during the financial crisis,” said one bank credit strategist. “The market is telling the Fed: if you don’t intervene, we are getting away from being a functional market.”
As a result, the difference between yields on mortgage-backed securities and those on 10-year Treasuries has doubled since a month ago to 1.5 percentage points — the widest spread since 2009, during the financial crisis, according to Bloomberg data.
American consumers are feeling the impact. The average rate for a 30-year fixed rate mortgage spiked to 4.12 per cent on Friday, up from 3.55 per cent at the beginning of the month and the highest since June 2019, according to Bankrate.com.
The development is frustrating for the Fed because it means reductions in its policy rate are no longer translating into lower mortgage rates. It also raises questions about whether a dramatic cut expected at its March 17-18 meeting will have the customary stimulative impact as Americans take advantage of lower mortgage rates to buy homes or generate savings by refinancing existing loans.
“In the past Fannie and Freddie would have come in and bought these securities,” said Jim Tabacchi, chief executive of South Street securities, a broker. “But they blew up [in the financial crisis]. The dealer community and the banks are the only ones making markets in these things . . . but even so they are at capacity. If they stop buying, mortgage prices are going to go up and up.”
Mr Tabacchi said the solution is for the Fed to enter the market directly and buy MBS. “They can relieve some of the pressure by using the its balance sheet to buy agency securities to create capacity until the market stabilises.”
Pimco, the California money manager, said in a blog post on Friday the widening spreads on MBS suggest that “pressures in that market are hindering the effective transmission of monetary policy . . . and to further ease financial conditions, the Fed could announce broader plans to purchase assets, including MBS.”