Agency MBS Update – October 2019

Monthly Commentary

November 05, 2019

Agency MBS relative performance was positive in October, reversing two months of negative excess returns as MBS finally caught a bid toward month end. There was a general risk-on theme this month, which began with the U.S. and China announcing the first phase of a trade agreement. Interest rates sold off on the news and remained higher until the end of the month when a dovish Fed cut rates by another 25 basis points (bps) while also effectively signaling that there will not be any near term interest rate hikes. The ensuing market reaction sent rates lower and risk assets were buoyed even higher with the S&P 500 reaching all-time highs. Despite this risk appetite, Agency MBS lagged in performance initially but eventually followed suit. In aggregate, the Bloomberg Barclays MBS Index returned 9bps of excess performance in October, bringing year to date excess returns to 5bps. Total return remained strong at 5.93% year to date.

Although agency MBS posted a marginal outperformance versus USTs, its performance continues to lag IG corporates. Year to date, agency MBS posted only 5bps of excess returns while IG corporates posted a whopping 475bps. As we navigate through a low interest rate environment, supply and prepayment concerns along with negative convexity continue to weigh on agency MBS performance. While rates sold off at the beginning of October, origination remained high at almost $4bln a day and prepayment speeds have yet to slow down. In fact, the September prepayment report surprised on the upside with FN 30yr speeds 11% faster than the previous month. The 2018 vintage continues to prepay fast with even lower coupon FN 3.0s peaking at over 60 CPR for the fastest pools. With rates off the secular lows and favorable seasonals ahead, prepayment speeds and supply could come in tamer in the upcoming months. However, it is important to note that only a portion of the UST rally in 2019 has been passed through to mortgage borrowers. The 30yr fixed mortgage rate has been lagging the interest rate rally primarily due to capacity issues as originators were not able to hire fast enough when interest rates fell. The Primary-Secondary Spread still remains wide and even when the 10yr UST sold off 31bps mid-month, the Freddie Mac Primary Mortgage Market Survey (PMMS) 30yr rate only went up 11bps from 3.64% to 3.75%. With over 50% of the MBS market still seen as refinanceable, prepayment speeds will likely remain elevated at current interest rate levels.

Coupon stack performance in 30yr conventionals favored down-in-coupon securities with FN 3.0s leading the stack at 15bps of excess returns. The higher coupon FN 4.0s and 4.5s had negative excess returns of 4bps and 9bps respectively as prepayment concerns weighed on performance. In GNMA MBS, most coupons outperformed their conventional counterparts. G2 2.5s and 3.0s were the best performers with 29bps and 24bps of excess performance as high demand from banks, servicers, and Asia overweighed new issue supply. G2 4.0s were the only exception, posting a negative 4bps of excess return as the carry profile deteriorated with the G2 4.0 roll turning negative this month. In specified pools, performance was rather mixed across the stack. Loan balance stories continued to be strong across coupons supported by buyers looking for duration and better convexity. Some weaker call protection stories in higher coupons, such as slightly seasoned conventional 4.0s, underperformed due to a wave of selling from end accounts as the slight seasoning provided close to no relief from speed prints well over 50CPR. All eyes will be on supply and speeds in the next couple of months to see if mortgages can make a stronger comeback as we head into year end.

Cumulative Excess Returns of MBS and IG Corporates, 1990 to Present

Source: Bloomberg, TCW

 

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This material is for general information purposes only and does not constitute an offer to sell, or a solicitation of an offer to buy, any security. TCW, its officers, directors, employees or clients may have positions in securities or investments mentioned in this publication, which positions may change at any time, without notice. While the information and statistical data contained herein are based on sources believed to be reliable, we do not represent that it is accurate and should not be relied on as such or be the basis for an investment decision. The information contained herein may include preliminary information and/or "forward-looking statements." Due to numerous factors, actual events may differ substantially from those presented. TCW assumes no duty to update any forward-looking statements or opinions in this document. Any opinions expressed herein are current only as of the time made and are subject to change without notice. Past performance is no guarantee of future results. © 2019 TCW