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Friday, October 03, 2014

Goldman: "Fed likely still holds $1 trillion MBS by the end of 2020"

by Calculated Risk on 10/03/2014 07:53:00 PM

Some interesting analysis from Hui Shan, Marty Young, Chris Henson at Goldman Sachs: Fed likely still holds $1 trillion MBS by the end of 2020

The QE program is set to end after the October FOMC meeting. In the updated exit strategy principles released on September 17, the committee announced that it anticipates (1) portfolio reinvestments will continue until after the first rate hike and (2) sales of MBS will not occur during the normalization process. The Federal Reserve currently holds close to $1.8 trillion agency MBS, accounting for one third of the total outstanding. Our US economics team forecasts the first Federal funds rate hike in 2015Q3 and the portfolio reinvestment continuing through 2015. This projection combined with the FOMC’s exit strategy principles suggests that the Federal Reserve is likely to remain the largest agency MBS investor for a long time.
The speed of the portfolio rundown when the Fed stops reinvesting depends on the speed of principal payments, both scheduled (i.e., through amortization) and unscheduled (i.e., through refinancing, home sales, and defaults). While scheduled principal payments are pre-determined, unscheduled principal payments depend on a host of factors such as interest rates, house prices, and economic conditions. ...

Under our baseline scenario, the Federal Reserve continues reinvesting principal payments through 2015. After that, the Fed portfolio declines slowly, with the Fed still holding $1 trillion MBS by the end of 2020. Such a gradual pace suggests that Fed portfolio rundown is unlikely to create a surge in the net supply of agency MBS for private investors to absorb after the end of QE.
emphasis added