Posts Tagged ‘Federal Funding Rate’

A round of applause

April 13, 2010

Seems people like to give the government (President, Congress, Federal Reserve, etc.) a hard time when things don’t go as planned. Rarely  does anyone give them the credit they sometimes deserve.

In regards to the Federal Reserve’s plan to lower interest rates and stabilize the mortgage back security bond market (MBS bonds), the Feds deserve a round of applause.

During the initial stages of the current financial crisis (when the markets were in total disarray), the Federal Reserve stepped in to the spotlight. The Feds announced a plan to buy MBS bonds with two goals in mind – to stabilize the value of MBS bonds and push interest rates down below 5%.  The Feds succeeded on both objectives, extended the program twice (for a total of 15 months), and spent over $1 trillion (yes, that is a “T” for trillion) buying MBS bonds.

The new concern became what would happen once the Feds program ended. Posts on this blog theorized that if MBS bond prices soared (and interest rates dropped) on the announcement of the plan in November 2008, wouldn’t the opposite occur once the Feds were finished buying MBS bonds?

Initially that theory proved to be right. In the first couple of days after the Feds stopped buying MBD bonds, those bonds dropped over 100 basis points in value and interest rates rose 0.25-0.375%. However, as the Feds bowed out of the MBS bond market, other investors have picked up the slack. For instance, since the Feds have kept the Federal Funding Rates near 0%, money managers, pension funds, etc. are moving away from playing it safe and keeping cash “on the sidelines” and are now investing in MBS bonds.

In the end, the plan seemed to work like a charm. The Feds were able to push rates below 5% (back below 5% at the time of this posting), stabilize the MBS bond market, and encourage other investors to pick up the slack as they slowly moved away from buying MBS bonds.

Even though the MBS bond market is now performing without a net, the initial “sky is falling” scare is over and interest rates have rebounded to their levels prior to the Feds leaving the MBS bond market. Who knows how this plan could affect the market a year or two down the road, or how rates will respond if they begin moving in the wrong direction (when they do rise, expect it to be sudden and without much warning), but at least for today, credit should be given to the Feds. Thus far, everything is going according to the plan they laid out. Besides, something bad could happen and we’ll think their idiots again tomorrow 🙂

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