Tuesday, November 25, 2008

Swap spreads tighten further -- good news

The first sign of improvement in the fundamentals was a decline in 10-year swap spreads, which fell to "normal" levels in the third week of September. Short-maturity spreads remained extremely high, however, and agency spreads rose last week to a new, exceptionally high level. Today these laggards are beginning to catch up, thanks to the Fed's announcement today that they will purchase up to $100 billion in GSE debt and up to $500 billion in mortgage-backed securities backed by GSEs. This is another in a series of government efforts to break the logjam that has been frustrating the fixed-income market. As I remarked when swap spreads first started to normalize, this is evidence that the government's efforts are gaining traction. As such, I think this is very positive for the outlook for all financial markets, since it enhances liquidity and reduces uncertainty, fear, and doubt.

With the Fed about to become a buyer for agency debt and mortgage backed securities, the yield on FNMA and FHLMC guaranteed mortgages has dropped by 55 bps today, which should mean that 30-year fixed mortgages should soon be available at 5.5% or so, which would be about the lowest rate available in many years. Lower financing costs and lower housing prices combine to produce a signficant improvement in housing affordability, and this in turn offers the promise of increased housing demand on the margin. The sooner prices stabilize the better for everyone.

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