Livermore, Pleasanton, Danville, Short Sale Specialist

3. Fed taper: Stimulus is going, going, gone

As we write this the Federal Reserve has begun the process of tapering purchases of Treasuries and mortgage-backed securities. Now started, it is a certainty that they will continue the process in 2014 and may completely halt qualitative-easing (QE) purchases altogether by mid-year. Of course, the economy will need to perform well — which is never a certainty — but an economy growing even modestly does not require the kind of emergency-level and extraordinary support the Fed has provided.

The QE program has been reduced to a $75 billion per month run rate, with reductions in purchases of both Treasuries ($5 billion) and mortgage-backed securities ($5 billion). If the economy cooperates, other steps could accompany the first four Fed meetings in 2014 (Jan. 28 to 29, March 18 to 19, April 29 to 30 and June 17 to 18) in reductions of equal size. However, the process could be a little more protracted than that, perhaps running through September, with two additional meetings.

One reason for the Fed to step out of mortgage-backed securities purchases is plain to see: The number of mortgage originations — and hence, the number of purchasable mortgage-backed securities — has been dwindling, what with the slump in refinancing which began in mid-2013. At one point, the Fed was “only” buying perhaps one-third of new government-sponsored enterprise mortgage backed-securities, or less. But as recently as November, the Fed’s purchases of mortgage-backed securities represented more than half of the market. The Fed wants to reduce its influence; however, its fixed-dollar commitment to buy these assets, rather than simply some flexible percentage of the market, means that as loan volume slips the Fed’s share grows. Although the Fed may leave this space, there should be an appetite for these high-quality securities, just as there was when volumes were higher, so the impact on rates should be limited.

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