Bonds Tied to Mortgages Poised for the Biggest Losses Since 1994

Bonds Tied to Mortgages Poised for the Biggest Losses Since 1994

Government-backed U.S. mortgage bonds declined after a two-day rally, extending quarterly losses that are on track to be the worst in almost two decades.

Fannie Mae’s 3 percent, 30-year securities fell about 0.2 cent today to 97.6 cents on the dollar as of 11:19 a.m. in New York, down from about 103 cents on March 28, according to data compiled by Bloomberg. A Bank of America Merrill Lynch index tracking the more than $5 trillion market lost 2 percent this quarter through yesterday, the most since the start of 1994.Mortgage securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae have been among the hardest hit as bonds tumbled amid signals from Federal Reserve officials that the central bank is moving closer to slowing the pace of its monthly debt buying known as quantitative easing, or QE.

“What just occurred is indicative of just how important QE is,” Brad Scott, Bank of America’s New York-based head trader of pass-through agency mortgage securities, said today in a telephone interview.

The Fed’s current buying provided demand as other investors retreated and has grown as a percentage of forward sales by originators tied to new issuance, which is set to fall as higher rates reduce refinancing, according to Scott.

“The Fed, at times during this period, was the only outlet in terms of demand for securities,” he said.

Bond Massacre

The mortgage-bond losses rival the 2.3 percent declines in the first quarter of 1994 amid a slump in debt prices sparked by the Fed unexpectedly raising its target for short-term interest rates on Feb. 4 of that year, the first of seven hikes totaling 3 percentage points. Fortune magazine at the time declared it a “bond market massacre.”

The current drop had eased in recent days, after the Fannie Mae 3 percent securities fell as low as 96 cents on June 25.

The sinking mortgage-bond prices have sent borrowing costs soaring. The average rate for a 30-year fixed mortgage rose this week to 4.46 percent from 3.93 percent, the biggest one-week increase since 1987, according to Freddie Mac surveys.

The Fed helped push mortgage rates to a record low 3.31 percent in November after beginning its third round of QE by adding $40 billion of new purchases of mortgage bonds to its existing program of reinvesting in the market.

Agency mortgage bonds have lost 0.95 percent more than similar-duration government debt this quarter through yesterday, the most since the third period of 2011, according to Bank of America index data. The underperformance is tied partly to the way in which the lifespan of mortgage securities extends as projected refinancing declines, as well as the potential slowing of the Fed’s buying in the market.

Debt Buying

Fed Chairman Ben S. Bernanke said on June 19 at a news conference that the central bank may “moderate” the pace of its $85 billion of monthly debt buying later this year and end the purchases around the middle of 2014.

The comments, which accelerated bond declines, came with some investors speculating that Fed officials would signal that they would be careful in withdrawing stimulus, and that the central bank might delay the step amid mixed economic data.

The Fed chairman’s remarks that day “made investors seriously question that mentality,” Bank of America’s Scott said.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net