Jeffery Lacker, president of the Federal Reserve Bank in Richmond, Va., said yesterday that
the Federal Reserve might not need to buy the full amount ($1.25 trillion) of agency MBS it is authorized under the agency MBS program.

Wells Fargo analysts noted in an Aug 18 report that foreign buyers are still increasing their net agency debt purchases, which includes MBS. At that time, they said that as foreign central bank purchases rise, the Federal Reserve will most probably lessen its purchases.

Even though Lacker did not specifically mention MBS foreign purchases, Wells Fargo analysts think that the Fed’s Mortgage Purchase Program was partly aimed at filling the demand gap caused by foreign buyers scaling back their MBS exposure.

Wells Fargo analysts looked at the relative value implications of the Federal Reserve decreasing its exposure to MBS.

Analysts do not view a dip in the activity of the mortgage purchase program as a negative for the agency MBS market, with the Fed’s purchase activity offset with continued foreign purchases. As a result, the analysts continue to remain neutral on the mortgage basis.

Analysts added that, to an extent, the Fed’s Mortgage Purchase Program has distorted relative price relationships between programs — FNMA, FHLMC, GNMA— as well as across the coupon stack. Wells Fargo analysts think that without the Fed’s activity price relationships will likely normalize and the relative value analysis will start to make more “sense.”

They added that  a slowing of the purchase program favors their current down-in coupon trade recommendation. Of the FNMA 4.5% available supply — $238 billion — the Fed owns $135 billion, or 56%. Analysts' said that with the Fed scaling purchases back, they think that there will be
rising CMO demand for the 4.5% coupon versus higher coupon collateral.

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