The FedTrade program has created low-coupon mortgages, which we believe are inflated in valuation and being employed by index buyers, says Paul Sularz, portfolio manager on the William Blair Fixed Income team. An active manager can use the mortgage-backed securities market to employ higher coupons, which provide more yield and income potential.
Watch the video or read the recap below.
The Fed has already begun to reduce its $4.5 trillion balance sheet, which contains high-quality U.S. Treasuries, agency debentures, and U.S. mortgage-backed securities. And what they’re doing on a go-forward basis is they’re just buying less of them. They are letting items mature, pay in full, and amortize in the case of agency mortgage-backed securities. They won’t be selling mortgages; they will just be buying less on a go-forward basis.
New buyers are going to have to come into the mortgage-backed securities market since the Fed has been exiting.
The Fed has created securities with very low coupons, in our opinion—anywhere from 4% and below, where the valuations are inflated. An active money manager can use the mortgage-backed securities market to employ the higher coupons, which provide more yield and more income generated than the lower coupons, which the Fed has been creating through its FedTrade program.
Those have dominated the index since the FedTrade program has gone on for a very long time, and the index buyers, the rules-based mandates, have been employing the low-coupon mortgages, which are inflated in valuation, in our opinion.