The Federal Reserve’s announcement that it will be extending Operation Twist disappointed mortgage investors as the statement did not include any additional mortgage purchases, according to a JPMorgan Securities midday report released Wednesday.

In fact, the mortgage basis weakened by 4-8 ticks after the announcement. Op Twist’s extension means that the Fed will continue reinvesting paydowns of about $25 billion per month back into mortgages versus gross issuance worth $110 billion per month, analysts said.

However, JPMorgan analysts said that this does not mean the Fed will not make any future action in the mortgage market.  Analysts even suggested that mortgage investors remain overweight the mortgage basis. They said that, while the news may have served as a disappointment to buyers, mortgage technicals remain positive. This is given that there is no net issuance and the $50 to $60 billion of bank and REIT sponsorship in 1Q12.

“We recommend staying overweight the mortgage basis, as fundamentals are still reasonable (OASs of Libor + 10-20 basis points for many coupons), carry is attractive versus Treasurys, and technicals are strong, thanks to zero or negative net issuance,” analysts wrote.

Furthermore, analysts recommended the down-in-coupon trade due to the carry advantage of lower coupons and the its OAS pickup compared to higher coupons. There is also policy risk in the higher coupons.

The Fed will likely raise the bar for future mortgage purchases by possibly requiring worsening economic environment before expanding further into MBS. It is also possible that the Fed can initiate QE3 if future market conditions permit and mortgages still have that potential upside in the future.

JPMorgan also examined previous scenarios to analyze how well mortgages performed with QE and Op Twist events. Analysts described QE2 as more of a Treasury event and thus an apparent disappointment for mortgage investors. In this case, mortgage performance was varied with higher coupons performing best and lower coupons underperforming Treasuys during the weeks that followed the events' announcement.

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