Unlike the Federal Reserve which can create reserves, Fannie Mae and Freddie Mac (GSEs) must fund their mortgage purchases. While they have significant retained earnings, they will likely need to issue short-term debt, creating a funding challenge as they buy long-duration assets with spreads that are negative to their funding costs.
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The Fed's intervention in funding markets, while not officially labeled Quantitative Easing, directly helps the Treasury finance its debt, effectively monetizing it and providing critical liquidity to markets.
Recent increases in funding market spreads suggest banking reserves may be too restrictive. This puts pressure on the Federal Reserve to end its balance sheet runoff (QT) sooner than its official timeline, creating a potential for market disappointment if the Fed delays its decision.
Despite the Fed's larger-than-expected asset purchase program, the primary near-term risk is that it may still fall short of the reserves needed for smooth market function, echoing the 2019 repo crisis.
The plan to buy mortgage bonds is not a direct solution for homeowners but a form of money printing (QE). This move likely props up banks holding increasingly unattractive mortgages as housing prices are pushed down, effectively bailing out financial institutions rather than individuals.
A U.S. administration decision for mortgage agencies to buy $200 billion in mortgages had an instant market impact, causing spreads to tighten quickly. In response, Morgan Stanley's mortgage strategy team moved from a positive to a neutral stance, demonstrating how fast regulatory news is absorbed by financial markets.
Fed rate cuts primarily lower short-term yields. If long-term yields remain high or rise, this steepens the curve. Because mortgage rates track these longer yields, they can actually increase, creating a headwind for housing affordability despite an easing monetary policy.
The Fed's plan to reinvest maturing mortgage-backed securities (MBS) into Treasury bills is a stealth liquidity injection. The US Treasury can amplify this effect by shifting issuance from long-term bonds to short-term bills, which the Fed then absorbs. This is a backdoor way to manage rates without formal QE.
The early end to the Fed's Quantitative Tightening (QT) is largely irrelevant for year-end funding pressures. The monthly $20 billion runoff is insignificant compared to daily swings in Treasury balances or money market funds. The primary drivers remain bank balance sheet constraints and regulatory hurdles.
Lacking demand for long-term bonds, the Treasury issues massive short-term debt. This requires a larger cash balance (TGA) to avoid failed auctions, draining liquidity from the very markets needed to finance this debt, creating a self-reinforcing crisis dynamic.
Enormous government borrowing is absorbing so much capital that it's crowding out corporate debt issuance, particularly for smaller businesses. This lack of new corporate supply leads to ironically tight credit spreads for large borrowers. This dynamic mirrors the intense concentration seen in public equity markets.