Because very strong fundamental macroenomic forces are pushing rates higher. Examples: US trade deficits, US budget deficits.
Because interest rates cycle from high to low to high--and we've just passed the low point for this cycle. Rates have already reached historic lows. You thought such rates were here to stay, perhaps?
Because very strong fundamental macroenomic forces are pushing rates higher. Examples: US trade deficits, US budget deficits.
Because interest rates cycle from high to low to high--and we've just passed the low point for this cycle. Rates have already reached historic lows.
It is also the the cost of the risk premium likely to be charged to the GSE's when they hedge their MBS portfolios.
See also: Contradictions: The Fed vs. the Bond Market
What Fannie and Freddie do is what good hedge funds should do. They go into the futures market to hedge their interest rate directional risk. You see, if short term rates were to rise above the average rates they have lent to their long term mortgage buyers, they could find themselves in the position of losing money. Lots of money. So they hedge.They do this in the Eurodollar futures markets. They use swaps or options on swaps called swaptions. (Swaptions are options contracts which, in return for a one-off premium payment, give you the right to enter into a swap agreement at the option expiration.) Again, nothing wrong with this.
Bianco notes the problem lies in that they need over a Trillion Dollars (that's with a "T") of these derivatives. In order to get a trillion dollars to line up on the other side of the trade (to take the risk from Fannie and Freddie), they have to pay a premium. Apparently it may be a big premium.
Bianco argued at lunch, in the shadow of the Chicago futures markets, that it is not the expectations of bond traders for actual rate increases, but the massive need for Fannie and Freddie to hedge its portfolio that drives the Eurodollar rates.
The mortgage debt market is now larger than the government debt market. One can make an argument it is the most significant piece of the US economy. Why take any risk at all?
Yet, if Bianco is right, the bond market sees more than a little risk, and that is why interest rate futures are priced so high in the face of the Fed telling us rates are going nowhere. If there were no risk to this trade, there would not be such high risk premiums.