Agency Mortgage-Backed Securities: Supply Yawn

The market shrugged off the Fed’s withdrawal as a buyer, but sector volatility could spike if prepayments rise.

November 19, 2018


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

Agency MBS performance was slightly negative in the third quarter, which ended with higher rates and a flatter yield curve. The Bloomberg Barclays U.S. MBS index posted a -0.12 percent total return.

Agency MBS Has Been Relatively Stable Amid Higher Volatility

Year-to-Date Performance

Agency MBS performance was slightly negative in the third quarter, which ended with higher rates and a flatter yield curve. The Bloomberg Barclays U.S. MBS index posted a -0.12 percent total return.

Agency MBS Has Been Relatively Stable Amid Higher Volatility

Source: Bloomberg, Guggenheim Investments. Data as of 9.25.2018.

Yields ended the quarter at 3.59 percent, 18 basis points higher than the previous quarter, while option-adjusted spreads were unchanged over the quarter. Conventional MBS underperformed GNMA, 30-year MBS underperformed 15-year MBS, and lower coupons underperformed higher coupons. Prepayment speeds were largely unchanged.

Higher Rates, Flatter Yield Curve Hurt Agency MBS Performance

Bloomberg Barclays U.S. MBS Index Spreads

Yields ended the quarter at 3.59 percent, 18 basis points higher than the previous quarter, while option-adjusted spreads were largely unchanged over the quarter.

Higher Rates, Flatter Yield Curve Hurt Agency MBS Performance

Source: Bloomberg Barclays, Guggenheim Investments. Data as of 9.30.2018.

The market has thus far absorbed the Fed balance sheet runoff without any major issues. Supply/demand technicals have been mostly balanced for the past six months, keeping spreads steady, though the sector has been vulnerable in recent market moves along with other sector spreads. Higher rates and wider spreads may further dampen supply and prepayments, improving the near-term outlook for the sector. We are seeing the increasing float of more negatively convex generic new production bonds, however, a situation we will continue to monitor. Without the Fed as an active buyer of these bonds, the private sector must absorb them, and we expect downward pressure on prices in the sector if prepayments rise. In other words, we view the broader sector as vulnerable in a large rate rally with the Fed out of the market. Careful security selection and active management will be vital in this market going forward, but we are well positioned to capitalize on this scenario.

We continue to favor investments in which either the collateral or structure offers some cash flow stability at reasonable spreads. 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.

—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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