Some investors worry mortgage rates could shoot up without the Fed’s support. But officials have been comforted by the fact that rates haven’t moved up even as they have slowed their buying.
The market reaction to a Fed pullback “will actually be a pleasant surprise,” said Ajay Rajadhyaksha, Barclays Capital’s head of U.S. fixed-income strategy.
When the Fed became the dominant buyer of mortgages, big investors such as mutual funds and insurers walked away from the market and purchased Treasury debt instead. Once the Fed stops, Mr. Rajadhyaksha said, there will be pent-up demand from private investors to soften the impact.
He expects Treasury and mortgage yields to rise no more than half a percentage point in coming months. Today, yields on 30-year fixed mortgages are around 5%.
The Fed plans to gradually reduce its mortgage portfolio. As mortgage-backed securities are paid off by borrowers, it plans to avoid reinvesting the proceeds in new securities. Mr. Sack estimates $200 billion of mortgage-backed securities will be pared from the Fed’s portfolio this way through 2011.
Officials are debating whether to adopt a similar policy for $140 billion of Treasury securities held by the Fed that mature by 2011.
Write to Jon Hilsenrath at firstname.lastname@example.org and Sudeep Reddy at