The following frequently asked questions (FAQs) provide further information about the Federal Reserve's reinvestment of principal payments from its holdings of agency debt and agency mortgage-backed securities (MBS) in agency MBS. The FAQs also provide additional information on small value agency MBS purchase exercises.
Effective September 14, 2018
How is the Desk implementing the FOMC's directive for agency MBS reinvestment purchases?
In October 2017, the Federal Open Market Committee (FOMC) initiated the balance sheet normalization program described in the June 2017 addendum to the Committee's Policy Normalization Principles and Plans. This program gradually and predictably reduces the Federal Reserve's securities holdings by decreasing the reinvestment of principal payments from securities held in the System Open Market Account (SOMA). Specifically, the FOMC directed the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York to reinvest the principal payments from SOMA holdings of agency debt and agency MBS received during each calendar month that exceed the cap amount for that month. If the anticipated amount of principal payments is lower than the cap in effect that month, then the Desk will not reinvest those principal payments. For the schedule of monthly caps, see: https://www.newyorkfed.org/markets/opolicy/operating_policy_170920.
How will the Desk determine the amount of funds to reinvest each month and how will this be communicated?
The Desk will calculate the agency MBS reinvestment amount by subtracting the monthly cap from the amount of principal payments from agency debt and anticipated amount from agency MBS to be received during a calendar month. On or around the ninth business day of each month, after receiving information from the agencies on expected principal payments, the Desk will publish the amount of agency MBS reinvestment purchases expected to take place between the middle of the current month and the middle of the following month. The announced purchase amount is subject to change should the FOMC alter its directive to the Desk during the month or if market conditions warrant. (See https://www.newyorkfed.org/markets/ambs/ambs_schedule.html)
As an example, consider the situation where a given month's cap is $4 billion and that the principal payments to be received from agency debt are $2 billion and the anticipated principal payments to be received from agency MBS are $18 billion. To determine the amount of reinvestment purchases of agency MBS, the Desk will subtract the $4 billion cap from the total principal payments of $20 billion ($2 billion from agency debt and $18 billion anticipated from agency MBS). An announcement will be made on or around the ninth business day of that month indicating that the Desk will purchase $16 billion of agency MBS, with operations starting on the following business day and running through the ninth business day of the following month.
The reinvestment amount reflects the principal payments anticipated to be received that month; however, actual principal payments received may deviate slightly from the anticipated amount. In addition, the actual reinvestment purchases may deviate slightly from the stated purchase amount due to operational reasons. The Desk will not make adjustments for these deviations in future months' purchases.
Is there a minimum amount required for conducting agency MBS reinvestments?
Yes. The Desk's monthly reinvestments in agency MBS will be subject to a $1 million minimum threshold due to technical requirements.
Will the Desk sell agency MBS if the monthly cap exceeds monthly principal payments from agency debt and agency MBS?
No. The cap is the maximum amount that SOMA holdings of agency debt and agency MBS will decline each month. If the total amount of monthly principal payments from agency debt and agency MBS is below the monthly cap amount, then the reduction in SOMA's agency debt and agency MBS holdings that month would be equal to the amount of principal payments, and no agency MBS reinvestments will occur.
When monthly principal payments from agency debt and agency MBS fall below the cap, will the Desk conduct any agency MBS purchases?
Yes. The Desk plans to conduct small value purchases of agency MBS for monthly periods in which principal payments fall below the cap. The purpose of these exercises is to maintain operational readiness in the event that principal payments exceed the cap and require agency MBS reinvestment purchases in the future, consistent with the Committee's balance sheet normalization program. Small value exercises are conducted under the annual authorization for domestic open market operations and do not represent a change in the stance of monetary policy. (See https://www.federalreserve.gov/monetarypolicy/files/FOMC_DomesticAuthorization.pdf)
How much will the Desk purchase in its small value operations each month and how will this be communicated?
Small value purchase operations will be up to $300 million for any given monthly period where principal payments are below the cap. However, the monthly purchase amount and monthly frequency of small value purchases could be adjusted over time. Additionally, if reinvestment amounts are very low over several months, the Desk may conduct both reinvestment purchases and small value purchases within the same month, however this is expected to be unlikely.
Similar to reinvestment purchase announcements, on or around the ninth business day of each month, the Desk will publish the amount of small value purchases expected to take place between the middle of the current month and the middle of the following month. The announced purchase amount is subject to change if warranted. (See https://www.newyorkfed.org/markets/ambs/ambs_schedule.html).
What types of agency MBS will the Desk purchase?
Agency MBS purchases will likely be concentrated in newly-produced coupons in 30-year and 15-year fixed rate agency MBS in the To-Be-Announced (TBA) market. These coupons are closely linked to new primary issuance and, accordingly, are closely tied to primary mortgage rates. The Desk may purchase other agency MBS if market conditions warrant. Only agency MBS guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae are eligible for purchase.
How will the FHFA Single Security Initiative impact the Desk's activity?
Under the FHFA's Single Security Initiative, expected to be implemented in June 2019, Fannie Mae and Freddie Mac will start issuing a new common security, called the Uniform MBS (UMBS), in place of their current offerings. Additionally, Fannie Mae and Freddie Mac TBA contracts are expected to be replaced by UMBS TBA contracts. In preparation for these changes, the Desk is developing the capability to purchase UMBS.
In addition, Freddie Mac will offer an exchange program that allows holders of Freddie Mac securities issued before June 2019 to convert these securities to UMBS. The Desk plans to convert some portion of existing Freddie Mac MBS holdings to UMBS, as appropriate. This will enable the Desk to more efficiently manage the SOMA portfolio through, for example, additional aggregation of Fannie Mae and Freddie Mac CUSIPs.
Collectively, these are matters of prudent advance planning and portfolio administration by the New York Fed, and no inference should be drawn about the timing of any change in the stance of monetary policy in the future.
How will agency MBS purchases be conducted?
The Desk will conduct purchases of agency MBS via FedTrade, the Desk's proprietary trading system. FedTrade operations will be conducted using multiple-price, competitive auctions with approved counterparties. A "multiple-price" auction is an auction in which the same security can be awarded at different prices, with awards given to participants at a price corresponding with an individual offer submitted to the operation. The minimum auction amount, offer size, and offer increment are each $1 million. Participants can submit up to ten offers per security, with each offer reflecting a price and par amount. Offers in FedTrade operations will be evaluated based on their proximity to prevailing market prices at the auction close.
How will the tentative schedule of FedTrade operations be communicated?
The Desk will publish a tentative schedule of FedTrade agency MBS operations twice a month, each covering a period of approximately two weeks. The first schedule will be released on or around the ninth business day of the month. The second schedule will be published on or around the nineteenth business day of the month and will run until the next purchase schedule is released.
The tentative schedule will include information on the upcoming operation dates, times, security types (agency and coupon) and maximum purchase amount per security. The schedule reflects reinvestment policy decisions that have been announced by the FOMC and/or small value purchase exercises, and is subject to change. No inference should be drawn about possible future adjustments to the stance of monetary policy from the schedule.
How often will purchases take place?
Purchases will be conducted on a regular basis over the course of each monthly period, with the timing guided in part by general agency MBS market conditions, including, but not limited to, supply and demand, market liquidity, and market volatility. The Desk may adjust the size, frequency and composition of agency MBS purchase operations depending on the monthly reinvestment amount. For months when the cap exceeds principal payments, the Desk expects to conduct about 1-2 small value purchase operations per week.
Will the Federal Reserve conduct agency MBS dollar rolls or coupon swaps?
The Desk may use dollar roll and coupon swap transactions if needed to facilitate settlement associated with its unsettled agency MBS purchases. A dollar roll is a transaction that generally involves the sale of agency MBS for delivery in one month with the simultaneous agreement to purchase agency MBS, with the same agency, tenor and coupon, for delivery in a different month. A coupon swap is a transaction that involves the sale of one agency MBS and the simultaneous purchase of another agency MBS, each with different agencies, coupons, and/or tenors.
The Desk would conduct dollar roll and coupon swap transactions via Tradeweb, a commercial trading platform. Transactions conducted over Tradeweb would be executed through a competitive bidding process in line with standard market practices.
Under what circumstances may the Federal Reserve conduct agency MBS dollar rolls?
Based on the directive from the FOMC, the Desk may conduct dollar rolls in order to facilitate settlement associated with its unsettled agency MBS purchases. Selling dollar rolls effectively postpones the settlement of outstanding forward purchase commitments, while buying dollar rolls effectively brings settlement forward. Dollar rolls would typically be conducted only if implied financing rates on agency MBS are notably below or above the general level of short-term interest rates, as such conditions may signal a shortage or abundance of supply, respectively, available for settlement. The Desk may conduct dollar rolls throughout the month, but at least two business days before TBA settlement dates. The amount of dollar rolls conducted may vary throughout the month depending on movements in implied financing rates.
Under what circumstances may the Federal Reserve conduct agency MBS coupon swaps?
Based on the directive from the FOMC, the Desk may conduct coupon swaps in order to facilitate settlement associated with its unsettled agency MBS purchases. However, the Desk does not anticipate conducting such transactions unless market conditions suggest that purchases are unlikely to be settled for quite some time, as suggested by dollar-roll implied financing rates that are persistently below the general level of short-term interest rates, prolonged fails, or other market functioning indicators.
Would agency MBS dollar roll or coupon swap transactions reduce the amount of total outright agency MBS purchases?
No. Dollar roll and coupon swap transactions are the simultaneous sale and purchase of the same face amount of agency MBS. Thus, they only affect the timing or composition of the settlement of the Federal Reserve's agency MBS purchases.
How will the Desk communicate the FedTrade operation results?
Operation results from FedTrade will be posted on the New York Fed’s website following each operation. The information posted will include the total amount of propositions received per auction, the total amount of propositions accepted per auction, the total amount accepted per security, and the settlement month. In addition, participating dealers will receive the operation results, including their accepted propositions, via FedTrade, immediately following the close of the auction.
How will the Desk communicate agency MBS transaction details?
The New York Fed publishes SOMA agency MBS transaction activity on its website on a weekly basis. Activity data includes the total amount of weekly purchases and dollar roll transactions by agency, coupon, maturity and settlement month. This information will include transactions conducted over FedTrade and Tradeweb, but will not include transactions related to small value exercises.
How are SOMA holdings of agency MBS reported?
Agency MBS transactions are reported after settlement occurs on the H.4.1. statistical release titled "Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks." This report also includes information on total outstanding commitments to buy and sell MBS in Table 3 entitled "Supplemental Information on Mortgage-Backed Securities." Trade settlements may occur well after trade execution due to agency MBS settlement conventions. The New York Fed also publishes on a weekly basis detailed data on all settled SOMA agency MBS holdings. Any change in the composition of these reported holdings over time is a function of principal payments, outright purchases and sales, CUSIP aggregation, dollar roll, and coupon swap activity.
When do SOMA holdings of agency MBS decline as a result of the FOMC’s balance sheet normalization program?
Declines in SOMA agency MBS holdings resulting from the FOMC’s balance sheet normalization program generally occur between one to three calendar months after the month in which the cap is applied. This is because settlement of agency MBS that are purchased through reinvestments can take place one to three months after the month in which the initial principal payments are received.
SOMA agency holdings are reported on a weekly basis in the H.4.1 statistical release. Over any period, changes in the H.4.1 line item “Mortgage-backed securities” reflect the net effect of the receipt of principal payments from holdings of agency MBS, settlement of any agency MBS purchased through reinvestments, and the settlement of purchases or sales of agency MBS associated with small value operational readiness exercises. Given the mismatch in timing between principal receipts and reinvestment settlements, agency MBS holdings fluctuate from week to week and do not reflect net declines during the calendar month in which the cap is applied.
For example, for the month of October 2017, SOMA agency MBS principal payments were approximately $24 billion, received on several dates over the course of the month, and there were no agency debt maturities. The monthly cap in October was $4 billion, so the Desk reinvested approximately $20 billion into agency MBS in purchases that took place between October 16 and November 13. Of those purchases, $12 billion settled in November and $8 billion settled in December. As a result, the $4 billion decline associated with the application of the October monthly cap would not be fully reflected on the H.4.1 until the end of December, after the final purchases from that cycle settle.
Will the Desk release operation pricing results?
Yes. In order to ensure the transparency of its agency MBS transactions, the Desk, at mid-month for the prior monthly period, will continue to publish historical operation results. This information will include the transaction prices in individual operations, including transactions related to small value exercises. In addition to the pricing information released each month, Section 1103 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 requires that detailed operational results, including counterparty names, be released two years after each quarterly transaction period.
Who is eligible to transact in agency MBS with the Federal Reserve?
The New York Fed's approved counterparties are eligible to transact in agency MBS directly with the Federal Reserve. Approved counterparties are expected to submit bids or offers for themselves and for their customers.
Whom should dealers call if they experience difficulties during a FedTrade operation?
Approved counterparties may call the New York Fed's Trading Desk with submission and verification questions. For FedTrade system-related problems, dealers may call the New York Fed's Primary Dealer Support line.
Does the Federal Reserve assess the TMPG agency MBS fails charge?
Yes. Effective February 1, 2012, the failure of the Federal Reserve's counterparties to deliver agency MBS for the contractual settlement date of the Desk's trades has resulted in the Federal Reserve assessing the applicable agency MBS fails charge recommended by the Treasury Market Practices Group (TMPG). Additional information can be found at https://www.newyorkfed.org/tmpg/index.html.
Does the Federal Reserve require the posting of margin for unsettled agency MBS trades?
Yes. The Federal Reserve requires counterparties to post margin to the New York Fed. Margin is calculated on a daily basis and serves to protect the New York Fed from counterparty credit risk exposure arising from the unsettled agency MBS TBA trades.
What is CUSIP Aggregation?
CUSIP aggregation is a process through which a number of existing MBS issued or guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae with similar characteristics, including uniform agency backing, coupon, and original term to maturity, are consolidated into a larger pass-through security. The aggregated CUSIPs are similar to those agency MBS being consolidated, except that the aggregated CUSIP represent groups of agency MBS, which themselves represent groups of residential mortgages that conform to specified requirements. The cash flows from the underlying agency MBS provide the cash flows for the aggregated CUSIP. Additional information about CUSIP Aggregation can be found on the Agency MBS CUSIP Aggregation FAQ page.