The Fed has more than one reason to hold onto the large ($1.6 trillion) in Agency Mortgage Backed Securities. A letter posted in the New York Federal Reserve’s blog, Liberty Street Economics by Allan M. Malz, vice president in the Federal Reserve Bank of New York’s Markets Group and other members of the group suggests a reason the mid-2013 abrupt yield jump did not morph into an even more protracted and harmful rate rise was the extent of Fed holding of high convexity mortgages.
Currently the Fed has much of those mortgage securities with the highest level of convexity exposure. We can be comforted that as a likely holder without need to hedge, the Fed’s position removes potential volatility from the long end of the yield curve.
As time marches forward, we should expect the Fed to continue to hold its accumulated Agency MBS position and eventually allow run-off. However, the volatility depressing benefit from the Fed’s maintenance of its Agency MBS portfolio will diminish as rates rise and the future production is taken not by the Fed but more so by those who will actively hedge their convexity exposure.