The US mortgage-backed securities (MBS) market is bracing for a potential, albeit limited, shift as the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac begin to deploy a combined $200 billion for MBS purchases. The move, directed by former President Donald Trump, has sparked debate among market participants about its likely impact on interest rates and market dynamics, with many concluding that the effect will be modest.
Fannie Mae and Freddie Mac historically played a dominant role in the US rates market, particularly before the 2008 financial crisis. They achieved this by actively buying qualifying mortgages from lenders, bundling them into MBS and crucially, hedging their risk exposure through interest rate derivatives and Treasury securities. At their peak, their combined MBS holdings exceeded $1 trillion, representing roughly a third of the overall market. This activity created a significant “duration gap” – a mismatch between the lifespan of their assets (mortgages) and liabilities (debt) – which they actively managed, influencing market flows.
“In those early years, the biggest number in the market was not payroll or inflation or GDP. The biggest number was the monthly GSE duration gap,” says Harley Bassman, managing partner at Simplify Asset Management, highlighting the scale of their influence.
Following the financial crisis and their subsequent government conservatorship, the GSEs significantly reduced their MBS holdings. This void was partially filled by the Federal Reserve and commercial banks, but neither entity engaged in the same level of active hedging as the GSEs, diminishing the cyclical relationship between MBS buying and rates hedging.
The recent directive from Trump to utilize the GSEs’ $200 billion cash pile to purchase MBS initially raised expectations of a renewed impact on rates. However, Bill Pulte, director of the Federal Housing Finance Agency (FHFA), clarified that the GSEs themselves would be responsible for the purchases.
Despite the directive, analysts believe the impact will be contained. Walt Schmidt, managing the mortgage strategies group at FHN Financial, notes that the MBS market is projected to grow by $200 billion this year, meaning the GSE purchases would absorb 100% of net supply. “That’s going to have an impact on spreads. I don’t think it’s really going to have any impact on the Treasury market. There’s not enough hedging there to cause a big convexity move,” he says.
Barclays’ MBS research team echoed this sentiment, suggesting that any uptick in implied volatility would be difficult to isolate from broader macroeconomic factors. The key difference lies in the GSEs’ diminished size and their current portfolio composition.
As of December , the combined retained portfolios of Fannie Mae and Freddie Mac totaled $272 billion, up 52% from $93 billion in May . While this represents the largest portfolio in years, it still accounts for only 3% of the outstanding market, compared to the Federal Reserve’s holdings of over $2 trillion and commercial banks’ $2.7 trillion. The GSE purchases may, in effect, offset the Federal Reserve’s ongoing balance sheet runoff, which reduced holdings by roughly $200 billion in .
A crucial aspect of the GSEs’ previous market influence was their active hedging strategy, designed to manage the negative convexity inherent in mortgage portfolios. Falling interest rates increase the likelihood of homeowners refinancing, shortening the duration of MBS. To counteract this, the GSEs would issue callable debt and utilize derivatives, including Treasury shorts, swaps, and swaptions. This process, while effective, created a cyclical pattern of buying and selling that other market participants often attempted to anticipate.
“They’d buy mortgage bonds. They would then short Treasuries, short futures, and pay fixed on swaps to offset the duration, and they would buy swaptions. That’s how you got big volatility in those years as Fannie and Freddie were manoeuvring these trillion-dollar portfolios up and down,” explains Bassman.
However, with the GSEs no longer actively managing a significant duration gap, this dynamic has largely disappeared. The current interest rate environment, with a substantial portion of homeowners holding mortgages at rates significantly below current levels, reduces the immediate risk of widespread refinancing.
“Nearly half the country is sitting on a 3% mortgage or less and with current mortgage rates in the sixes, we would need a tremendous rally to move them. But the longer we remain at these rate levels and continue to issue higher rate mortgages, the more we increase the refinance exposure of the overall market,” says Tom Mansley, head of MBS strategy at GAM Investments.
Deutsche Bank strategists suggest that any increase in GSE holdings will likely be hedged by paying fixed on SOFR swaps, which would widen swap spreads. However, the overall impact is expected to be moderate, given the GSEs’ reduced market share and the changing dynamics of the MBS market.
The $200 billion purchase, while noteworthy, appears unlikely to fundamentally alter the trajectory of interest rates or significantly reshape the US mortgage market. It represents a partial return to a previous dynamic, but one constrained by the GSEs’ current size and the broader economic landscape.
