Not sure if this is the exact board for me to ask this, but this is the best I can do (I find it sometimes hard to navigate around this version of the forum).
I was watching Fast Money on CNBC and one of the traders said the following (not an exact quote), in regard to mortgages: “With the Fed rolling off MBS on its balance sheet, that will absolutely put upside pressure on mortgage rates.”
What exactly does this mean? Thanks…
The Federal Reserve owns a lot of assorted fixed income securities, currently some $6.7 trillion worth. They buy more when they think the bond market needs support and then later sell them. Their balance sheet peaked about three years ago.
Mortgage backed securities make up about $2.2 trillion of the total (about a third). As these are sold the extra supply puts downward pressure on prices and upward pressure on yields.
DB2
Ha, welcome to our world.
@esxokm welcome to the METAR Board. Your question is absolutely on-topic.
METAR is an investment analysis board which exists to discuss the economy and all investments, including stocks, bonds, real estate, precious metals, etc. We value all opinions including bulls, bears and every shade in between.
@DrBob2 gave you an excellent answer. Please let me add to it.
MBS are “Mortgage-Backed Securities.” A mortgage is a debt and therefore falls into the broad category of bonds.
Mortgage originators (lenders) carry some risk because the borrower may default. In order to diffuse the risk the originator often sells the mortgage to a brokerage.
The originator gets cash which it can lend out for more mortgages.
The brokerage “bundles” the specific mortgage with many other mortgages. The bundle of mortgages generates a bundled cash flow. The brokerage evaluates the credit ratings of each mortgage holder in the bundle and then “slices” the bundle into “tranches” of similar credit ratings.
These tranches of debt are put on the market for investors to buy to get income. They are called “mortgage backed securities” or MBS. They are derivatives because they have been massaged, sliced and diced and aren’t the original security (which was a collection of simple mortgages). The bundles are then sold to investors.
The roots of the Great Financial Crisis of 2008 were in 1. many unqualified borrowers being loaned mortgages for houses they couldn’t afford and 2. many MBS being created with credit ratings that investors trusted but were stronger than they deserved.
Like all investments, bond prices (and the MBS that contain mortgage bonds) respond to supply and demand. If there is more demand the price will go up. With bonds, the interest rate goes up when the price goes down. The interest rate goes down when the price goes up.
The Federal Reserve bought a huge amount of MBS with money it created out of thin air. @DrBob2 showed the chart. By increasing the demand for MBS the Fed pushed the price up and so the interest rate went down. This fed into the marketplace where the mortgage rate went down.
Now the Fed is “rolling off” its MBS. That mean that the Fed will not buy new bonds when the old bonds mature. You can see this in the line that is sloping down.
The Fed provided a huge demand for MBS which isn’t there anymore. With less demand the price of MBS is going down. That means the yield is going up.
MBS are mortgage-backed securities. As the yield goes up the increase is passed along to individuals who want mortgages to buy a home.
You can see from this chart how the 30-Year Fixed Rate Mortgage Average in the United States rose at the same time that the Fed’s investment in MBS fell.
That is the exact meaning of the sentence you asked about.
Wendy
Me too on Wendy’s welcome.
Now, with the depth and utility of her answer, you also know why she is unquestioned Empress and Final Arbiter on METAR.
Tell us how you are doing.
DrBob2, thank you for the reply. This helps me understand what was said on the show, I really appreciate the time. Always find the bond side complicated, to be honest.
Wendy, thank you as well for the reply. It’s a great primer for a topic I always find confusing. And funny, I remember some of this, to a certain extent, from the movie The Big Short, but of course it wasn’t fully explained there.
If I have more questions I will be sure to use this board, and in fact, probably will, because the CNBC traders are always talking about bonds, but they talk so fast and obviously can’t stop to explain, it gets confusing (e.g., bond auction didn’t go well, 10-year at slightly over 4 is a good sign, etc.).
Thanks again for the welcome…
Flyerboys, thank you for your reply and welcome. The replies from DrBob and Wendy have me doing well, they helped me to understand what the guy meant. And if you mean as well how am I doing investment-wise, definitely down, but trying to add when I can (in fact, that’s what really has me down - money has been tight, so can only spare so much for my Roth stuff).
Take care…
IAGolfer, that’s hilarious! I am definitely not opposed to change and improvement, but I got so used to the old board as an older Fool that, unfortunately, I still haven’t gotten used to the free side yet (at some point I will try to re-subscribe, I know there are some better navigation opportunities when paid). I think it is the tags and such that sometimes throw me off (and I guess I can’t create tags or stock designations to post specific questions about specific companies).
@esxokm I enjoyed “The Big Short” very much but I felt that a lot of it wouldn’t be understood by people who aren’t already immersed in the arcane world of finance.
If you are interested in bonds I recommend that you study them in Investopedia.
In fact, it’s a good idea to read Investopedia about any investment you plan to make.
Wendy
Same here. If you have not seen “Margin Call” do so. You will probably like it just as much.
