Fed should buy more MBS to avoid market "accident" - Barclays

March 20 (Reuters) - The Federal Reserve should increase its purchases of mortgage-backed bonds to reduce the risk that relative weakness in the asset class will lead to forced selling that could create an "accident" in the market, analysts at Barclays Capital said.

Investors have sold assets ranging from stocks to low risk U.S. Treasuries this week as fears grow about the economic consequences of prolonged business shutdowns as governments battle to stop the spread of the coronavirus.

Bonds that are backed by mortgages issued by Fannie Mae, Freddie Mac and Ginnie Mae have been among the assets sold as the market is relatively liquid, which makes them easier to sell than some other fixed income asset classes, Barclays analysts Ajay Rajadhyaksha and Dennis Lee said in a report sent on Friday.

The Federal Reserve on Sunday slashed rates to zero and launched a new bond purchase program that will include at least $500 billion in Treasuries and $200 billion in MBS in an attempt to improve liquidity in the markets. Despite this, Mortgage-backed bonds have underperformed Treasuries, Barclays said.

If this continues there is a risk that leveraged asset managers including mortgage real estate investment trusts (REITs) will need to offload the assets, which in turn would lead to even more selling.

"If this continues for the next few days, there is risk of an accident in the agency MBS market, with forced selling on an ever-larger scale,” the analysts said.

“We are not worried so much about the price at which agency MBS clears (and what it means for the level of mortgage rates), but rather the chaos and lack of market liquidity that might ensue for an extended period of time in the event of an accident in the agency MBS space.”

To offset this risk Barclays recommends that the Federal Reserve increase its purchases of mortgage-backed debt to $500 billion.

(Reporting By Karen Brettell; editing by Diane Craft)