The Fed’s mortgage bond holdings fell $186 billion in a year while its bill holdings rose $376 billion

The Federal Reserve’s mortgage-backed securities fell by $11.7 billion in the week to October 28, to $1.884 trillion ^[1]. Over the past year the portfolio has lost $186 billion ^[1].

Its October directive tells the New York Fed to “reinvest all principal payments” from agency securities into Treasury bills ^[4]. The money that homeowners pay back on mortgages in the Fed’s pools goes into short-term government debt, not new mortgage bonds.

Bills are replacing mortgage bonds on the Fed’s books

Treasury bills held by the Fed reached $571.5 billion on October 28, up $376 billion from a year earlier ^[1]. Nominal notes and bonds rose by $40 billion and inflation-protected securities fell by $30.5 billion ^[1].

Of the $1.884 trillion in MBS, $1.767 trillion has more than 10 years left before final maturity ^[1]. Runoff depends on how fast homeowners sell or refinance, not on bonds maturing.

The gap between mortgage rates and Treasuries is wider than a year ago

Freddie Mac’s 30-year rate averaged 7.24% in the week of October 29, against 6.17% a year earlier ^[5]. The 10-year Treasury yield was 4.94% on October 30, up from 4.11% a year before ^[6].

We calculate the spread at 2.30 points now and 2.06 points a year ago. The Fed has not tied mortgage spreads to its runoff, but with the Fed reinvesting into bills ^[4], private investors are the buyers of new mortgage bonds.

How to use this

For homebuyers and refinancers

1. Ask lenders to quote the spread they are pricing over the 10-year yield, and compare quotes on the same day. We calculate that a 0.24-point difference in rate, the amount the spread widened in a year, changes the payment on a $400,000 loan by about $65 a month at current levels.
2. Judge each quote by its spread over the 10-year, not only by the Fed’s next rate decision. The Fed’s MBS shrank $186 billion in a year ^[1], and its directive sends those paydowns into bills rather than mortgages ^[4], so the Fed is not buying new mortgage bonds.

For builders and home sellers

1. Price buyer incentives off the 30-year rate buyers face, now 7.24% ^[5], not off the 10-year Treasury. A buydown that assumes a 2.06-point spread from last year ^[5][6] would understate what it costs to bring a buyer’s rate down today.

For mortgage investors and lenders

1. Track the weekly change in the Fed’s MBS line on the H.4.1. It fell $30 billion between September 2 and October 28 ^[1][2], and faster paydowns would show up there first.
2. Plan for refinance-driven prepayments to stay slow while rates are above a year ago. The Fed’s holdings are 94% in pools with more than 10 years left ^[1], and those pools pay down mainly when owners sell or refinance.
3. Compare the Fed’s bill holdings with Treasury’s bill supply. The Fed added $376 billion of bills in a year ^[1], and reserve management purchases can continue “when appropriate,” in the directive’s words ^[4].