August 23, 2018
Agency MBS spreads have the potential to modestly widen as levels are still historically tight, and 2018 net supply is expected to exceed that of the previous few years, but carry remains attractive and could absorb most of our expected spread widening. We expect the sector to continue to provide diversification and lower volatility within a broad fixed-income portfolio, as the current environment of range-bound rates, low volatility, and reasonable valuations relative to credit sectors will result in support from investors continuing to look for opportunities to add high-quality spread assets. Moreover, relatively steady performance despite market volatility in the first half of this year validates the sector’s defensive profile.
Agency MBS performance was positive in the second quarter despite headwinds in the form of higher rates and a flatter yield curve. The Bloomberg Barclays U.S. MBS index posted a 0.24 percent total return. Yields ended the quarter at 3.41 percent, wider from the previous quarter, while option-adjusted spreads were roughly 1 basis point tighter over the quarter. Conventional MBS underperformed GNMA, 30-year MBS outperformed 15-year MBS, and lower coupons underperformed higher coupons. Prepayments speeds increased marginally over the quarter.
We continue to favor less negatively convex assets 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, better call-protected pools, and some collateralized mortgage obligation structures. We continue to avoid assets, such as Ginnie Mae MBS, where valuations are relatively stretched and may be affected more by the Fed’s policies or changes in regulatory regime.
Relatively steady performance in Agency MBS relative to corporates despite market volatility in the first half of this year validates the sector’s defensive profile.
Source: Bloomberg, Guggenheim Investments. Data as of 6.27.2018.
Despite market concerns that the Fed’s balance sheet normalization would cause spreads to widen significantly in Agency MBS this year, we have seen option-adjusted spreads only a little wider since October 2017, and spreads range-bound on a zero-volatility basis. Yields ended the quarter 3.41 percent, higher than the previous quarter, while option-adjusted and zero-volatility spreads are one basis point tighter quarter over quarter.
Source: Bloomberg Barclays Indexes, Guggenheim Investments. Data as of 6.29.2018. The zero-volatility spread measures the spread that an investor will receive over the entire Treasury spot rate curve. LHS = left hand side, RHS = right hand side.
—Aditya Agrawal, CFA, Director; Louis Pacilio, Vice President
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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