Market participants believe the availability of new mortgage production is an obstacle to QE3 despite Federal Reserve Chairman Ben Bernanke's supportive comments in his semi-annual congressional testimony on Tuesday, BNP Paribas MBS analysts said in a report released yesterday.

BNP's data showed that 30-year MBS issuance for 1H12 was $473 billion or roughly $79 billion per month.

However, the Fed is already paying for about $24 billion per month in 30-year MBS, leaving approximately $55 billion in additional MBS. That amount should be further haircut to account for specified pools, which the Fed has not traded.

With prepayments increasing in the coming months, issuance should be higher analysts said. As the Fed portfolio prepays, purchases should increase, although the issuance pick up would outstrip it, analysts explained.

Buyers such as money managers might be overweight on mortgages as they expect an MBS purchase program. They can probably provide added supply along with banks, which have elevated MBS holdings. For instance, large banks' MBS holdings have risen by $42 billion year-to-date and are off their peak in early April.

Analysts currently favor a modest overweight on the mortgage basis as increasing QE3 prospects with a mortgage focus is expected to support the sector. With the 10-year Treasury rate at roughly 1.50%, which analysts expect to rally further to 1.25%, incremental yield should become increasingly significant.

Overseas investor demand seems to have also resurfaced with the QE3 talks. BNP analysts cited the latest Treasury International Capital System report that showed foreign investors added 8 billion in agency MBS in May and have added 21.8 billion year to date. They also expect REIT equity raises to be supportive.

Bernanke Testimony

BNP economists characterized Bernanke's testimony as "QE3-friendly as possible under the circumstances." The Fed chairman enumerated "a fairly generic menu of options" such as Treasuries and MBS purchases and extending rates guidance.

Bernanke said that "available indicators" point to a sub-2% growth performance in 2Q12, which is a key assesement since the number is much lower than the Fed’s current projection of a 2.5% trend. The Fed is now looking at whether the data imply that a sustainable labor market recovery is underway.

BNP economists also said that given that the labor market is a lagging indicator, and the economy is growing at a below-trend pace, the chances are not good that it will return to a pace significantly above 125,000 on payrolls, which is what is required to bring the unemployment rate down steadily.

“While the Chairman continues to stress that “monetary policy is not a panacea”, he certainly feels there is still enough leverage in QE policies to help get the economy unstuck again,” analysts said. 

Bernanke reported that the Fed is actively examining the possibilities for easing, which will be discussed at the next Federal Open Market Committee meeting.


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