Neuberger Berman's Brad Tank explains the impact of reduced monthly Fed purchases of Treasuries and mortgage-backed securities – and how investors can take advantage of it.
The financial markets are currently talking almost daily about when and to what extent the Fed will reduce its monthly purchases of government bonds and mortgage-backed securities from U.S. mortgage lenders. Central bank wants maximum transparency so markets don't get nervous. In this context, Fed Chairman Jerome Powell expanded on the Federal Reserve's vocabulary: "We are discussing tapering to discuss.""Even Alan Greenspan has to give him credit for this"", Says Brad Tank, CIO fixed income at Neuberger Berman.
Resounding effects of the first taper
Given the resounding effects of the first taper – after the international financial crisis – the high level of interest in the market is all too understandable. A 100 basis point increase in the US ten-year yield would have a massive impact on prices today. However, no one is counting on a repeat of 2013. The Fed is likely to proceed cautiously to avoid a market reaction similar to the one it had back then. "So investors are discussing the Fed's likely actions and the impact on yields, but they are somewhat overlooking the relationship between government and mortgage bonds. One-third of the Fed's 120 billion in net monthly securities purchases. USD is attributable to mortgage-backed securities. The central bank has clearly said that it wants to reduce purchases proportionally", according to Tank.
Yields on mortgage-backed securities below three-year average
Currently, yields on mortgage-backed securities are about 15 basis points below their three-year average. Neuberger Berman expects that the three-year average could be approached at the start of taper and that yields will rise by a maximum of 30 basis points. Record low yields and a booming residential real estate market have been responsible for more than a bio. USD net issuance of mortgage-backed securities, a large portion of which has been underwritten by the Fed. Quite unusual for the early part of the business cycle, however, was also the extensive buying by commercial banks, whose capital base and ratings have not suffered under Corona. Meanwhile, most of the capital for private borrowers is being supplied by the currently very receptive financial markets.
During the recent government bond rally – from May to early August – mortgage-backed securities gained only about half as much. According to Tank, Neuberger Berman has therefore been selling government bonds and buying mortgage-backed securities for tactical reasons – in the belief that rising yields will offset some of these shifts. "If tapering leads to spread widening, Neuberger Berman plans to buy more of them. Agency securities are mostly a base investment in Neuberger Berman's investment grade and multi-sector portfolios. Today, the share of these securities in many portfolios is slightly below their long-term average. In this context, Neuberger Berman would like to see the Fed exit the market: Then it would be possible to earn a little more again with these important securities. So investors need not fear tapering. They should use it to their advantage", Commented Tank.