Wells Fargo analysts similarly estimate that if the GSEs are able to spend at least $100 billion in purchases, the move could strengthen the MBS base by 20 basis points (bps), all else being equal. “A tighter base could indirectly reduce mortgage rates, which could dilute the yield function at lower coupons and drive supply expectations,” they wrote.
On Friday morning, Paradise said the 5.0 MBS coupon yield had improved by about 50 bps. That move could translate into an improvement in the lending rate of around 7 to 10 bps compared to earlier in the week.
Currently, Keefe, Bruyette & Woods analysts added that, although the spread between agency MBS and Treasuries has tightened and stands at about 89 bps, in line with the long-term industry average, “we don’t think there is any reasonable room for the spread to tighten.”
“However, spreads were around 25 bps in the pre-Covid period so we can see tightening,” they wrote in the report.
Who supports the MBS market?
Historically, Fannie and Freddie have used their reserve portfolios to support housing affordability, acting as small buyers of MBS and guarantee funds.
Before entering conservatorship in 2008, the GSEs had aggressively expanded their portfolios – including exposure to risky debt – before The Federal Reserve came in as a dominant buyer through price cuts following the financial crisis.
The Fed, however, is moving in a different direction. In October, Fed officials announced that principal payments from MBS would be reinvested in Treasuries, further reducing the central bank’s footprint in the housing market.
“President Trump’s mandate appears to indicate that the GSEs may match the Fed’s lack of price sensitivity, which would mean tighter spreads and higher mortgage rates,” Morgan Stanley analysts said in a report.
Morgan Stanley analysts wrote that the $200 billion purchase program would be equal to the Fed’s annual MBS rate cut, suggesting a possible tightening of about 15 bps. And if interest rates are hedged, mortgage rates could end in 2026 at around 5.6%, in line with their strategic rate forecasts. That situation would increase existing home sales from the initially expected 4.23 million to somewhere in the 4.25 to 4.30 million range.
But Realtor.com Chief economist Joel Berner added in a statement that the Fed continues to hold $2 trillion in MBS even after three years of reducing its holdings, and “without that same level of moderation and credibility, any impact on mortgage rates is likely to be modest and short-lived.”
Banks have also withdrawn from the MBS market since the financial crisis, forced by stricter capital controls. As a result, a growing share of MBS is now held by money managers, raising questions about whether they will add to positions or take profits as Fannie and Freddie combine to trade, according to Wells Fargo analysts.
GSEs funds
Fannie and Freddie added $37 billion in MBS to their portfolios held between January and November, including $15 billion in November alone. Since Bill Pulte took over the role of director at Federal Housing Finance Agency (FHFA), the GSEs added $54 billion.
Morgan Stanley analysts expect MBS issuance to total $175 billion by 2026, driven largely by Ginnie Mae debts. That flexibility could create disparities unless the GSEs expand their ability to manage portfolios of Ginnie Mae securities, which are often tied to loans to veterans and low-income borrowers.
Each of the GSE’s reserve portfolios currently stands at $225 billion, and Morgan Stanley estimates there is about $179 billion of excess capacity. The $200 billion Trump mentioned includes restricted cash and securities purchased under resale agreements.
That means the GSEs could fund more MBS purchases by selling loans, reallocating assets or amending Preferred Stock Purchase Agreements (PSPAs) to increase portfolio limits, analysts said.
“Another question is what this does to their capital needs and ability to privatize, as we would expect them to need more capital compared to a large reserve portfolio, potentially pushing back the timeline of reinvestment plans,” added Morgan Stanley analysts.
