Mortgage Traders Play Down Need For Further Fed Aid

Federal Reserve policy makers are keeping open the option to prop up the mortgage market even after its $1.25 trillion mortgage securities purchase program ends in March, documents released Wednesday show, but traders played down the idea that such help would be necessary.

The test is how the housing market, which is on a fragile recovery path, weathers the loss of government support. Many traders and portfolio managers actively support the government's exit, since its wholesale purchases of mortgage-backed securities has skewed their market projections and analyses.

There was little market reaction to the possibility that the Fed may extend its mortgage program, as discussed in minutes of the policy committee meeting that were made public Wednesday.

"We still expect the Fed to stop purchases in March, and [to] reserve the right if needed to come back and purchase more," said Ajay Rajadhyaksha, head of fixed-income research at Barclays Capital.

As long as mortgage rates stay within 1.75 percentage points of Treasury bond yields, there will be no panic, Rajadhyaksha added. Mortgages are currently about 1.26 percentage points above comparable Treasury yields, little changed on the day. The spread peaked at 2.83 percentage points in March 2008.

Market participants estimate that rates on 30-year fixed loans will rise to about 5.5%, from the current 5.05%, when the government stops buying mortgages. Investors will demand a higher return for taking on risks now shouldered by the Treasury.

If the market pushes mortgage rates close to 6%, however, then there may be a need for the Fed to re-enter the market, as the Fed policy makers discussed in December.

The minutes noted that "a few members observed that it might become desirable at some point in the future" to extend the central bank's large-scale asset purchases beyond the first quarter, "especially if the outlook for economic growth were to weaken or if mortgage market functioning were to deteriorate."

The concern was the "risk that improvements in the housing sector might be undercut ... as the Federal Reserve's purchases of MBS wind down, the homebuyer tax credits expire, and foreclosures and distress sales continue."

-By Prabha Natarajan, Dow Jones Newswires; 212-416-2468; [e-mail]