Text on screen: What'd happened in the MBS market?

Daniel H. Hyman, Head of Agency MBS Portfolio Management: Over the last two weeks, we’ve seen agency mortgage valuations reached their cheapest levels since the financial crisis. 

Chart: The line graph depicts the spread of the U.S. 30-year mortgage rates vs. the 10-year Treasury yields from 1999 to 2020. The line starts low, sharply spikes in 2009 and then moderates to low again whith slight peaks and troughs to the current period, which is rising.

We see this clearly looking at the spread between the current coupon mortgage rate and US 10 year treasury. 

What’s different this time is Fannie and Freddie are currently not a going concern unlike they were during the financial crisis, they currently reside in conservatorship and have a credit line to the US treasury. What we have seen in the last 2 weeks, we believe has been a crisis of liquidity. 

We’ve seen the central bank respond with rate cuts, we’v  seen the central bank respond with 500 billion in quantitative easing to buy treasuries and we’ve seen the central bank respond with 200 billion of buying in agency mortgages and announcing the end to the tapering or selling of their mortgages.

Text on screen: What has been the impact?

In the near term we expect the impact of the Federal Reserve’s policies to have a materially positive impact on the government guaranteed and agency mortgage sectors for 2 main reasons. 

First, at the main cause of the underperformance, it was investors, levered investors selling, with the improvement in prices we’re seeing in government guaranteed mortgages this should stop the need for levered investors to sell. 

Second, we’ve seen a material change in the supply and demand dynamics in the market. A week ago the market was expecting the Federal Reserve to sell 240 billion mortgages this year, they are now going to buy 200 billion mortgages, a swing of 440 billion mortgages, an enormous number and an enormous change in expectations. We think this combination should lead to improved prices, improved spread levels and a normalization of mortgage pricing in the coming months. 

Text on screen: What's next?

It will take a bit of time as the feds, through their purchases, absorbs the excess supply but in time we believe there should supportive of markets and leaves us with an optimistic view on the government guaranteed and agency mortgage sectors, as well as securitized products.

We believe the long term impact of the central bank policies will be beneficial for markets and beneficial for the sector.

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Disclosure

The terms “cheap” and “rich” as used herein generally refer to a security or asset class that is deemed to be substantially under- or overpriced compared to both its historical average as well as to the investment manager’s future expectations. There is no guarantee of future results or that a security’s valuation will ensure a profit or protect against a loss.

Past performance is not a guarantee or a reliable indicator of future results. 

All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. U.S. agency mortgage-backed securities issued by Ginnie Mae (GNMA) are backed by the full faith and credit of the United States government. Securities issued by Freddie Mac (FHLMC) and Fannie Mae (FNMA) provide an agency guarantee of timely repayment of principal and interest but are not backed by the full faith and credit of the U.S. government. The credit quality of a particular security or group of securities does not ensure the stability or safety of an overall portfolio.

There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.

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