Market reveals resistance to Fed’s latest view of QE3

April 5 (Bloomberg) -- Ben S. Bernanke’s Federal Reserve signaled this week it isn’t ready to buy more bonds to stimulate the economy. Mortgage investors aren’t convinced.

Trading in the market for government-backed mortgage bonds is showing a 37% chance of a third round of so-called quantitative easing, or QE3, according to Credit Suisse Group AG calculations. While that’s declined from 40% last week, it’s up from 25% after the April 3 release of the minutes of the Fed’s monetary-policy panel meeting last month.

Stocks, commodities and bonds declined after the statement, which showed certain members support easing only “if the economy lost momentum.” Treasuries and mortgage securities pared losses yesterday with some investors speculating the Fed will eventually acquire more home-loan debt to bolster consumer spending and support a housing market the minutes described as “depressed.”

“Mortgages didn’t underperform in a truly meaningful fashion,” said Jason Callan, head of structured products at Columbia Management Investment Advisers LLC in Minneapolis, which oversees about $180 billion in fixed income. “The likelihood of QE was modestly diminished, particularly in terms of the April meeting, but that doesn’t take it off the table for later.”

After Fannie Mae’s 3.5%, 30-year mortgage securities underperformed similar-duration interest-rate swaps by 0.34 cent on the dollar on April 3, the most since October, the home-loan notes outperformed by 0.25 cent yesterday, according to data compiled by Bloomberg.

Bellwether to Buying

Trading in the $5.4 trillion market for so-called agency mortgage securities relative to fixed-income benchmarks such as Treasuries and interest-rate swaps is serving as a QE3 bellwether because any program may focus on home-loan bonds after Fed Chairman Bernanke sent a study to Congress in January that highlighted how housing is restraining the economic recovery.

The central bank acquired $2.3 trillion of bonds in two rounds of quantitative easing from December 2008 until June 2011, including $1.25 trillion of agency mortgage securities. In September it announced it would buy $400 billion of longer-term U.S. securities through June while selling an equal amount of shorter-term debt in its holdings, and start reinvesting proceeds from its housing debt back into the mortgage market.

The probability being assigned to QE3 is now “too high,” Credit Suisse analyst Mahesh Swaminathan in New York, said in an e-mail. After the Fed’s statement, his team recommended bets that mortgage bonds will underperform, based on the central bank’s “incrementally hawkish sentiment.”

Further Easing

Four Federal Reserve regional bank presidents who vote on monetary policy this year said this week they see less of a need for the Fed to spur the economy with new accommodation.

Richmond’s Jeffrey Lacker said yesterday he “was surprised a couple months ago at the probability market participants seemed to ascribe to further easing.”

Jobless claims fell 6,000 to 357,000 in the week ended March 31, the fewest since April 2008, the Labor Department reported today in Washington.

A report on the state of the U.S. job market tomorrow also may show the unemployment rate held at 8.3 percent, according to estimates compiled by Bloomberg. While that would match the rate in January and February, the lowest in three years, it may provide the Fed with evidence that consumers and housing need additional help.

Housing Recovery

Home-loan securities guaranteed by government-supported Fannie Mae and Freddie Mac and U.S.-owned Ginnie Mae have returned 0.99 percentage point more than Treasuries this year through April 4, according to Barclays Plc index data. The rally was partly driven by investors who anticipate QE3, such as Pacific Investment Management Co.’s Bill Gross.

The Fed has already helped push borrowing costs on new mortgages to record lows. Almost 90% of new home lending goes through government-supported programs fueled by the agency mortgage-bond market, making the debt key to the level of loan rates, according to newsletter Inside Mortgage Finance.

Even with that assistance, the housing recovery remains fragile. Property prices dropped five consecutive months to a 10-year low in January, according to an S&P/Case-Shiller home- price index. New-home sales fell to a 313,000 annual pace in February, the slowest since October, the Commerce Department said March 23. Existing-home sales eased to a 4.59 million annual rate from January’s 4.63 million pace, according to the National Association of Realtors.

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