By Albert Durso, Senior RMBS and CMBS Strategist, Yield Book
The MBS market began the month in a guarded stance, as the latest in a series of highly anticipated Fed meetings held the sector at bay.
Once the FOMC meeting passed (May 5), rates having been raised an expected 50 basis points and MBS selling put on the back burner, spreads began to tighten, and the index was an outperformer for the first time in several months.
MTD index performance gained +82 basis points against riskless Treasury benchmarks. Prices for MBS were over ½ point higher, outpacing Treasuries which veered lower. 10yr U.S. treasuries yields lowered 11 basis points to 2.87% (touching 3.14% pre-FOMC), 2s10s yield curve operated in a 30bps range (net steeper 3 basis points), with 3m10y Vols easing 20bps (+104), as Fed Speak and related “noise” ceased over the final two weeks of May.
MBS Current Coupon performance dropped 27 basis point to 3.98%, OAS levels were 4 bps wider (36.4), Zvols tightened 15bps (100.3) and against 5&10yr Treasury blend narrowed 9bps (+116.5) on the month.
Years to date; spreads are 45-50 basis points wider on spread levels (OAS, ZV, and v5&10yr tsys), but 8-16 bps narrower than from the pre-FOMC wides as relative value buyers found the sector too good to ignore with current month outperformance further underscoring that move.
Ahead, the market has priced in an additional 100bps Fed Funds rate hike in the next two months (June/July), with less and less credence being given to headline risk associated with MBS Sales by the Fed.
The TBA stack is “tri-furcated” among a plethora of coupons; lower 30yr 2.5%s and below are basically leftovers from the Federal Reserve that have 10yr averages lives, trade at 9–15-point discounts to par, are less liquid, and can only subsist on sustained rates rallies. In fact, pricing on this sector is somewhat vague and generally contributes to any index underperformance as mark-to-market valuations are largely subject to opinion on this illiquid segment.
As we move higher in coupon, 30yr 3%s and 3.5%s comprise what is referred to as the “belly” of the stack, predicated upon relative value plays from money managers and other fast money types (hedge funds) policing rich/cheap movements.
Lastly, the upper stack of 4%s and higher are now the production coupons, dominating what amount there is left in Originator TBA pipelines, serving bank and Asian demand for current yield. As that daily amount is a mere $2.5 billion, demand is more than sufficient to absorb supply, assuming no new adverse headlines regarding Fed moves.
Dollar roll levels have been most expensive in 30yr 4.5%s and 5%s, cooling down once settlements passed (mid-month), with back month supply now more plentiful.
The May/Jun FNMA 5% roll hit +19/32nds during the 48hr day/settlement cycle, affording B/E financing of -1.99%; versus +12/32nds carry profile (using 25 WALA off thinned supply CTD profiles). After Class A rolled, Jun/July rolls lowered ¼ point back nearer 10/32nds.
A popular play this month has been lower coupon 3s, tightening precipitously as extension risk maxed out at times, warding off any rates back up while capitalizing on recent rallies. On the other side of that equation, is shorter 4%s that have a bigger upside should the market continue the previous rates backup.
From the Yield Book table (below); Into a 100bps back up in rates, 4%s fare slightly better gaining more yield and remaining shorter-owing to a more negatively convex profile than 3s (-1.43 v -1.2). 3%s, for that matter, remain 1.3yrs longer into a 100bps rates rally, losing 6 bps less yield than 4%s, with duration shortening to 4.1yrs (vs. 2.85yrs on 4%s).
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