Fannie and Freddie Add Billions to the Bond Market
According to Bloomberg, and have been increasing the mortgages and mortgage-backed securities they hold on their own balance sheets. At their peak, before the financial crisis, Fannie and Freddie held a combined total of $1.6 trillion in mortgages.
As we share below, courtesy of Bloomberg, their portfolio sizes are well below what they were, but they have begun to grow. To wit, Bloomberg notes that their combined portfolios have increased by 25% over the past five months and could increase further. There are three potential rationales for the growth.
- By absorbing mortgages that would have gone to the secondary market, the supply of fixed-income products declines, pushing yields on MBS and Treasuries lower.
- Fannie and Freddie’s actions will compress MBS spreads toward UST yields, thereby improving housing affordability on the margin.
- If the administration plans to sell Fannie and Freddie to the public via an IPO, larger balance sheets should translate into higher stock prices, resulting in a larger windfall for the government.
From a market perspective, the reemergence of GSEs as meaningful buyers changes the dynamics of the agency MBS market, with implications for all fixed-income markets. In addition to reducing MBS risk premiums, as noted above, their actions should dampen market volatility.
The key question is whether this remains a temporary tool or is a prelude to a sustained balance-sheet expansion. Per the Bloomberg article:
“If the ramp-up in the GSEs’ portfolios continues, they would become one of the most important buyers in the market, and that would force investors to pay very close attention to their every move,” said Mario Ichaso, a strategist at Wells Fargo & Co. “The mantra becomes, ‘Don’t fight the GSEs.’”
Time For A Rotation To Utilities?
The SimpleVisor rotation tracking tool shown below indicates that utilities are significantly oversold on both an absolute and a relative basis. At the same time, the transportation sector has been the most overbought for the last few weeks. From a fundamental and historical perspective, one could say the market believes the economy is rebounding to the benefit of the transportation sector.
As a result, interest rate-sensitive sectors will be negatively impacted by higher interest rates that often accompany strong growth. If, however, you don’t subscribe to that view, we can use technical analysis to compare the two sectors and identify when the relative performance between transportation and utility stocks may shift in utilities’ favor.
The second graphic shows and applies technical indicators to the price ratio between the utility and transportation sectors. As we highlight in the box, the ratio has declined from approximately 0.55 to 0.45, indicating utilities have underperformed by about 20% over this relatively short period. The middle graph is our proprietary momentum oscillator.
The ratio is very oversold, but the signal has not yet crossed above the oscillator, so it does not indicate a potential change in direction. The MACD at the bottom suggests the relationship is very extended, consistent with our gauge, and has yet to show a bullish crossover in utilities’ favor. That said, the gap between the lines is narrowing and appears to be approaching a crossover. Such a crossover may be a strong early signal that utilities are poised to outperform transportation stocks.
While not shown, the MACD on the utilities-to-S&P 500 price ratio just registered a buy signal from low levels. Bottom line: keep an eye on utility stocks, as their recent underperformance may be nearing an end.
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