By Albert Durso, Senior RMBS and CMBS Strategist, Yield Book
U.S. Agency Mortgages slumped after a promising start to the new year, as rising Vols detracted from embedded call structures like MBS. Supply ticked up above recent month levels, providing headwinds against production coupons while lower coupons are completely dependent on rates rallies and “mark to market" pricing as trading is fleeting there.
Volatility is a huge component in MBS performance and the tale of the tape can be read daily in 3m10Y Vols (historically a suitable proxy for MBS). That tenor rose higher 13% on the month to 115.40, taking mortgage hopes lower. Longer tenors, namely 5Y10Y and 1Y10Y were modestly changed overall but did experience a rise from the lows at mid-month.
U.S. 10yr note yields rose 53bps to 3.93%, while the 2s/10s curve inverted yet another 16bps to -87.30. MBS Index results gave back 31basis points overall to Treasuries, while both remain heavily underwater two months in at -231bps+.
Originator supply increased another 17% from last month to $2.17 billion per day, with borrowers locking against the fear of even higher rates. The 30yr primary rate rose 52bps to 6.65% (FHLMC PMMS), while Bankrate’s daily quote spiking above 6.95%. Current coupons continue to be focused on 30yr 5%s and 5.5%s (74.7%), with the wings of the coupon stack (7%s and 4%) now less than 1% of the output.
Into the selloff/spread weakness, Relative Value accounts bought outright, while Banks and Hedge Funds sought lower prices in general. Money Managers were UIC (Up in Coupon) movers at mid-month, while Asia was relatively tame.
The FHA cut the annual Mortgage Insurance Premium (MIP) rate 30 basis points in a somewhat long overdue move to expand lending to first time home buyers and FHA borrowers. It is unlikely this MIP cut will have a material effect to borrowing versus a backdrop of higher rates.
Lastly, prepayment speeds on agency MBS fell again in last month’s recap, down 17% along UMBS and 18% in GNMA space.
Market Perspective- Where the Coupon Stack is Concentrated
MBS issuance has taken a nosedive the past year plus, as rising rates, falling refinances and limited repeat business has shrunk originations. With the Federal Reserve no longer minding the store on asset purchases (mortgages especially), QT has replaced QE with the battle against inflation of primary importance.
The bulk of production was derived in the last leg of QE, when the onslaught of Covid 19 forced the Fed back on the buyback program (May 2019). 10yr T-note rates plunged from 2.60% to a 2020 low of 0.53%, while 30yr mortgage rates went from 4.17% to 2.65%. Since that time frame, we have retraced higher +260 to +330 basis points along MBS and Treasuries.
A look at the resulting production showed a refinancing wave where the upper stack was obliterated and replaced by lower coupons, en masse.
From the chart below, the predominance of lower coupon 30yr 2%s and 2.5%s is plainly evident. The Current Face, or RPB, is presently at 52.3% of the approximately $8.4 Trillion in Agency MBS. Logically, with those average note rates hovering between 2.75% and 3.318% respectively, it makes sense that refinancing is out of the question as a turnover source. Similarly, 93.5% of the universe is contained in net coupons from 2% to 4.5% with the higher coupons note rate averaging 4.98%-well below the current Freddie Mac PMMS reading of 6.50%.
This stack entrenchment has held the index performance hostage to rates rallies and mark to market outcomes, with little to no trading down in the bulk of MBS Outstanding. Current and production coupons are prey to originations but, their overall impact upon performance is immaterial, percentage wise.
MONTH TO DATE: Spreads and levels mirrored the more in rates, with both fading and softening into month end, after a poor finish to January 2023. The 30yr current coupon (par-based UMBS CMM) rose 86 basis points (5.73%), OAS softened 19bps to 31.4, ZV measures wider 27bps to 142.1 and the closely followed correlation to 5&10yr Treasury blend gapped 19bps to 144.7.
Year to Date: Things have evened out for the first two months, with results fairly muted for now. 30yr CC levels are up 39bps, OAS wider 21bps, ZVs wider 11bps, and vs the 5&10yr treasury blend +6bps.
For more on MBS and other asset classes, subscribe to the FTSE Russell blog.
© 2023 London Stock Exchange Group plc and its applicable group undertakings (the “LSE Group”). The LSE Group includes (1) FTSE International Limited (“FTSE”), (2) Frank Russell Company (“Russell”), (3) FTSE Global Debt Capital Markets Inc. and FTSE Global Debt Capital Markets Limited (together, “FTSE Canada”), (4) FTSE Fixed Income Europe Limited (“FTSE FI Europe”), (5) FTSE Fixed Income LLC (“FTSE FI”), (6) The Yield Book Inc (“YB”) and (7) Beyond Ratings S.A.S. (“BR”). All rights reserved.
FTSE Russell® is a trading name of FTSE, Russell, FTSE Canada, FTSE FI, FTSE FI Europe, YB and BR. “FTSE®”, “Russell®”, “FTSE Russell®”, “FTSE4Good®”, “ICB®”, “The Yield Book®”, “Beyond Ratings®” and all other trademarks and service marks used herein (whether registered or unregistered) are trademarks and/or service marks owned or licensed by the applicable member of the LSE Group or their respective licensors and are owned, or used under licence, by FTSE, Russell, FTSE Canada, FTSE FI, FTSE FI Europe, YB or BR. FTSE International Limited is authorised and regulated by the Financial Conduct Authority as a benchmark administrator.
All information is provided for information purposes only. All information and data contained in this publication is obtained by the LSE Group, from sources believed by it to be accurate and reliable. Because of the possibility of human and mechanical error as well as other factors, however, such information and data is provided "as is" without warranty of any kind. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the accuracy, timeliness, completeness, merchantability of any information or of results to be obtained from the use of FTSE Russell products, including but not limited to indexes, data and analytics, or the fitness or suitability of the FTSE Russell products for any particular purpose to which they might be put. Any representation of historical data accessible through FTSE Russell products is provided for information purposes only and is not a reliable indicator of future performance.
No responsibility or liability can be accepted by any member of the LSE Group nor their respective directors, officers, employees, partners or licensors for (a) any loss or damage in whole or in part caused by, resulting from, or relating to any error (negligent or otherwise) or other circumstance involved in procuring, collecting, compiling, interpreting, analysing, editing, transcribing, transmitting, communicating or delivering any such information or data or from use of this document or links to this document or (b) any direct, indirect, special, consequential or incidental damages whatsoever, even if any member of the LSE Group is advised in advance of the possibility of such damages, resulting from the use of, or inability to use, such information.
No member of the LSE Group nor their respective directors, officers, employees, partners or licensors provide investment advice and nothing in this document should be taken as constituting financial or investment advice. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any representation regarding the advisability of investing in any asset or whether such investment creates any legal or compliance risks for the investor. A decision to invest in any such asset should not be made in reliance on any information herein. Indexes cannot be invested in directly. Inclusion of an asset in an index is not a recommendation to buy, sell or hold that asset nor confirmation that any particular investor may lawfully buy, sell or hold the asset or an index containing the asset. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.
Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back-tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.
This document may contain forward-looking assessments. These are based upon a number of assumptions concerning future conditions that ultimately may prove to be inaccurate. Such forward-looking assessments are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially. No member of the LSE Group nor their licensors assume any duty to and do not undertake to update forward-looking assessments.
No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the applicable member of the LSE Group. Use and distribution of the LSE Group data requires a licence from FTSE, Russell, FTSE Canada, FTSE FI, FTSE FI Europe, YB, BR and/or their respective licensors.