The rise in U.S. Treasury yields has been very impressive considering where stocks are – the Dow is just 80 points away from 10,000 – and the improvement in economic data. But it’s even more incredible that it happened without the aid of investors in mortgage-backed securities and mortgage servicers that typically snap up longer-dated debt like U.S. Treasuries and swaps to hedge their portfolios when interest rates fall sharply. It’s known as convexity hedging, and it was a powerful accelerator in the U.S. Treasuries market in 2002 when the Federal Reserve was pushing rates down. (It also works the other way. When rates rise suddenly, it forces mortgage investors to quickly start selling longer-dated debt.)
When the medication is flowing, it’s hard to see straight.
Amid the giddiness in the markets and the cheers for the end of the recession, what often gets ignored is the fact that government stimulus is still fueling the reflation of financial markets.
Barclays has come up with an interesting way to solve an optical problem. Concerned that the bank’s shareholders are nervous about possible future writedowns of wobbly assets with a value of $12.3 billion, it has sold them to its own employees.
Looking quickly at the Fed balance sheet, I stumbled upon the “off balance sheet” quirk of its mortgage-backed security holdings. The Fed reports this week that its holdings through Wednesday Sept. 2 stand at $625 billion. But we know from the NY Fed data released yesterday that the central bank has bought $817.6 billion MBS so far this year.
It’s often said on Wall Street that the more liquidity there is in a given market, the better things are for investors trading stocks, bonds or commodities. And while there’s a lot of truth to that, there are times when too much liquidity can be just the wrong tonic.
Barring another serious economic stumble, it seems that the Fed is not going to offer much more credit easing than already planned. The minutes of the June meeting of the FOMC suggested a solid resistance to stepping up purchases of either mortgage backed securities or Treasury bonds.
OK, it’s not a majority owner, but the government has an impressive stake in the $4.5 trillion agency mortgage-backed securities market. Barclays Capital’s last count, as of July 3, puts Federal Reserve purchases at $621.6 billion since it launched the program in January. Separately, the Treasury Department has picked up more than $145 billion since the government put Fannie Mae and Freddie Mac in receivership in September. The Treasury data is through the end of May.