This week’s chart highlights the price performance of agency mortgage-backed securities (MBS) and residential mortgage refinancing activity since Q4 2018, when Treasury yields hit their post-financial-crisis highs. We compare the prices for three major cohorts within the U.S. government agency MBS universe — 30-year 2 ½’s (14.7%), 30-year 3’s (26.9%) and 30-year 3 ½’s (23.7%). Refinancing activity is measured by the Mortgage Bankers Association (MBA) Refinance Index, a weekly report for the number of mortgage refinance applications.
Two years ago, the interest rate environment was nearly the mirror opposite of today, as 10-year Treasury yields touched 3.25% and Federal Reserve (Fed) Chair Jerome Powell signaled the tightening cycle was still in the early innings. Today, the Fed is “not even thinking about raising rates” and long-term yields remain near record-low territory as the U.S. economy struggles to fully recover from the coronavirus pandemic.
The sharp fall in rates this year has turned the typical price relationship among 30-year MBS coupons (i.e., higher coupon = higher dollar price) upside down, as prepayment risk and challenging liquidity conditions have weighed on valuations among higher-coupon MBS. The MBA Refinance Index reached its highest levels in more than a decade as numerous borrowers had their first window to refinance at lower rates. The Fed’s renewal of agency MBS purchase activity beginning in March was concentrated in the 3-year 2.5% coupon and likely exaggerated the relative underperformance of high-coupon MBS this year.
The convergence of trading levels around the 105 dollar level for three of the largest and most liquid coupons in the agency MBS market this year highlights how fast prepayments remain a headwind for performance in the sector. However, the concentration for Fed purchase activity in newer production agency MBS does provide attractive opportunities for investors who can identify trends in demand and prepayments across the coupon stack and securities with superior call protection.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice. The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete. Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements. Actual results may differ significantly. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.
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