Fed MBS Runoff Portends More Negative Vega for the Broader Market

With much anticipation and fanfare, the Federal Reserve is finally on track to reduce its MBS holdings. Guidance from the September FOMC meeting reveals that the Fed will allow its MBS holdings to “run off,” reducing its position via prepayments as opposed to selling it off. What does this mean for the market? In the long-term, it means a large increase in net supply of Agency MBS and with it an increase in overall implied and realized volatility.