In 2006, foreign investors created demand for MBS and filled in the gap that other investors like the GSEs used to fill. Street analysts are predicting that this demand is going to continue this year. Specifically, UBS analysts said in a report released last week that both official and private foreign investors will remain very active in the U.S. MBS sector.

On the government side of foreign investing, analysts explained that central banks have fundamentally changed their foreign exchange reserve equal to three to six months of imports, and were invested mainly in U.S. Treasury Bills, analysts said. This, in turn, resulted in dollars being available to cover the imports. They also said that asset liquidation did not really result in losses. But, in the past decade, foreign exchange reserves are up more than three fold (from $1.55 trillion at year end 1996 to $4.75 trillion at the end of third quarter 2006). Because of this, central banks reoriented their foreign exchange reserve management to reflect a total return tendency. The U.S. dollar share of foreign exchange reserves has been notably constant at roughly 63% of the total. However, they said that central banks have significantly increased their allocation of dollar reserves toward spread product. And, in the past few years, the mortgage market has, according to analysts, benefited disproportionately from this move.

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