How Will the FED Cut its Mortgage Backed Securities Holdings?

Tomorrow, the FED will meet again to make the decision regarding interest rates. Most experts expect 2 more rate hikes this year. Interestingly, Brian Chappatta  of  Bloomberg reported that hedge funds are going long treasuries

For the first time since July, hedge funds and other large speculators are bullish on Treasuries across the yield curve, U.S. Commodity Futures Trading Commission data show. The shift in 10-year futures was particularly striking, with the group adding an unprecedented 255,942 net-long contracts as of the latest figures, covering the week through April 25. Their bias is so skewed toward gains that the group is the most vulnerable to a bond-market selloff since 2008. 

Their change of heart came at a risky time. While almost no one expects the Federal Reserve to raise interest rates Wednesday, traders are betting that officials will reiterate a plan to hike twice more this year and potentially deliver further signals on their intention to trim the central bank’s balance sheet. What’s more, the same day, the Treasury is set to release documents as part of its quarterly refunding announcement that could shine light on the prospect of ultra-long debt issuance, which has already sent 30-year securities tumbling. Read more

Along with the issuance of ultra long-term debts, traders will closely watch the Fed’s decision regarding the unwinding of its Mortgage Backed Securities holding. As we wrote before, the unwinding of its Mortgage Backed Securities can increase market volatility

Today, concerns regarding the MBS were raised again, as pointed out by Rich Miller

Such securities can unexpectedly come due early if home owners decide to move or to refinance their mortgages. So, if the Fed wants its drawdown to be predictable, it will have to actively manage its holdings and not just passively accept what happens in the market.

He was referring to the prepayment risks embedded in Mortgage Backed Securities

While the Fed has made clear its desire to rid itself of much of its mortgage-backed debt, it’s not been so forthcoming on how far it wants to reduce its asset holdings overall. Read more

Let’s watch the FED tomorrow