Market action and possible reaction to Fed action or inaction

Ahead of tomorrow’s FOMC meeting where the debate now rages over what the Fed will do with the proceeds of the maturing MBS securities they own, totaling about $200b in 2011, MBS are rallying again today, sending the 30 yr FNMA coupon down to 3.45%, matching the lowest on record dating back to 1984. The spread to the 10 yr US Treasury is narrower by 7 bps to 61 bps, near the recent historic low of 54 bps reached a few weeks ago. I reiterate that in terms of its economic impact, what the Fed announces with regards to this issue I believe is irrelevant at this point. On the other hand, what they will do will impact asset prices. With the trial balloon the Fed laid with the WSJ article last week on this issue and the immediate market rally, market participants now have to be careful if the Fed DOESN’T follow thru and if so, we’ll likely see a sharp US Treasury/MBS selloff.

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