Agency Mortgage-Backed Securities: New Year, New Market Dynamics

While short-term drivers for spread tightening are in place, we expect modest widening later in the year.

February 23, 2018


This Agency Mortgage-Backed Securities sector report is excerpted from the First Quarter 2018 Fixed-Income Outlook.

Agency MBS performance was positive in the fourth quarter, driven largely by carry as the quarter ended with higher rates and a flatter yield curve. Rangebound rates, low volatility, and reasonable valuations relative to credit sectors have resulted in stable Agency MBS spreads as investors continue to look for opportunities to add high-quality spread assets to their portfolios. Prepayments speeds were steady over the quarter. Agency MBS spreads have the potential to widen modestly from here as readings are tight compared to historical levels, and 2018 supply is expected to be higher than in recent years. However, we view this technical dynamic as disproportionately affecting Ginnie Mae (GNMA) MBS over Fannie Mae (FNMA). The GNMA share of outstanding Agency MBS has increased from approximately 10 percent to 30 percent over the last decade, as its share of net supply has been much higher. Strong demand for GNMA MBS from domestic banks and Japanese investors has resulted in GNMA MBS trading at tighter spreads or at higher prices than FNMA. However, demand from these sources is likely to be more muted going forward, even as demand from the Fed declines.

GNMA’s Share of the Agency MBS Market Has Tripled in the Past Decade

Share of Outstanding Agency MBS by Issuer

The GNMA share of outstanding Agency MBS has increased from approximately 10 percent to 30 percent over the last decade, as its share of net supply has been much higher. Strong demand for GNMA MBS from domestic banks and Japanese investors has resulted in GNMA MBS trading at tighter spreads or higher prices than FNMA.

GNMA’s Share of the Agency MBS Market Has Tripled in the Past Decade

Source: Bloomberg, Barclays, Guggenheim Investments. Data as of 12.31.2017.

The Bloomberg Barclays U.S. MBS index posted a 0.15 percent total return in the fourth quarter of 2017. Yields ended the quarter at 2.91 percent, higher than the previous quarter, while option-adjusted spreads were roughly 3 basis points wider over the quarter. Conventional MBS outperformed GNMA, 30-year MBS outperformed 15-year MBS, and lower coupons outperformed higher coupons.

We currently favor securities with less interest rate sensitivity—less negatively convex—where either the collateral or structure offers some cash flow stability. Accordingly, we find select subsectors attractively priced in the current environment, including longer-maturity Agency multifamily bonds, new collateral types recently introduced by the government-sponsored enterprises, and some collateralized mortgage obligation structures. We continue to avoid assets, such as GNMA MBS, where valuations are relatively stretched and which may be more negatively affected by the Fed’s balance sheet runoff or a potential easing of the Basel Liquidity Coverage Ratio, which has motivated a portion of bank demand in recent years.

Agency MBS Spreads Widened Slightly in the Fourth Quarter

Bloomberg Barclays U.S. MBS Index Option-Adjusted Spread

The Bloomberg Barclays U.S. MBS index posted a 0.15 percent total return in the fourth quarter of 2017. Yields ended the quarter at 2.91 percent, higher than the previous quarter, while option-adjusted spreads were roughly 3 basis points wider over the quarter.

Agency MBS Spreads Widened Slightly in the Fourth Quarter

Source: Bloomberg, Barclays, Guggenheim Investments. Data as of 12.31.2017.

—Aditya Agrawal, CFA, Director; Louis Pacilio, Vice President

 
Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.

Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management. ©2018, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.


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