William_Potter
By Albert Durso, Senior RMBS and CMBS Strategist, Yield Book
MBS Rallies to Weaker CPI, Diminished Supply Headwinds
U.S. Agency Mortgages began the month meandering toward another subpar performance until November 10th’s CPI report altered the rates landscape. A surprisingly weak figure rallied rates and more importantly rallied MBS to new Index heights, this just two months after plunging to new depths.
U.S. 10yr note yields shaved basis points off the previous highs (4.21%), and the 2s/10s curve steepened 26 basis points before its inevitable resumption to inversion. Price action was supported as well, rallying 3 points across the entire MBS index, with a month-end rally added in for good measure.
MBS tends to do better in rallying markets, as the bulk of the outstanding universe still resides in discounted coupons with longer average lives that feed off longer-end outperformances. In fuller and shorter coupons, intermittent outperformance vs. the lower stack was rare yet noticeable along 6%s and 6.5%s. 7%s have also seen a modest uptick in activity though “quoted” markets still lack trading frequency of their lower coupon compatriots.
Originator supply has really taken a more dramatic turn lower, with daily TBA hedging down to $1.6B from $2.6B as recent as August 2022. 53% of those hedged coupons lie between 5.5%s, and 6.5%s this past month, as borrowers pay points upfront to avoid the stigma of paying a 7% interest rate.
While the month was a resounding success, outperformances were capped on occasion as money managers and hedge funds continued to police the tights, selling the basis focused on “belly” coupons 4.5%s through 5.5%s. Markets tend to ebb and sway with wides bought up and tights sold so don’t expect too much relative outperformance as we head to year-end.
Dollar roll markets remained sedate with only fuller 6.5%s and 7%s nearing or exceeding carry (breakeven). In fact, the “picture” along FNMA 7% roll is a 10/32nds bid, 6/32nds below carry/break even (using a conservative 10CPR that infers new production filtering in over more seasoned paper).
MONTH TO DATE; Spreads had an outstanding month, firming dramatically, post-CPI print as noted above, with the par-based current coupon lowering 70.5 basis points to 5.174%. OAS spreads were equally impressive tightening 40.7 basis points to 10.196, while ZV spreads narrowed 29.158 bps (126.5), and measures against the frequently watched 5&10yr Treasury blend tightened 30.5 bps to +141.14.
YEAR TO DATE: Results are in a different mode annually, as 11 months of rising and widening haven’t been reversed out just yet; 30yr CC +312bps, OAS +23bps, ZV +76bps, and vs the 5&10yr treasury blend +74bps.
Market Perspective
More activity has been occurring in the upper 30yr stack of UMBS, with markets traded along 6.5%s and bid-ask more regularly quoted on 7%s.
We felt it timely to explore further using Scenario Analysis that employs a curve shift ahead of the upcoming December Fed meeting (Dec 13th/14th).
The recent Fed Speak language bandied about appears to lean more towards a 50bps tightening as opposed to the previous 75bps sentiment. This leads us to a summary of +/- 100 basis points scenario, better encapsulating, we hope, the immediate rates backdrop horizon.
Of the three upper coupons examined, fuller 7%s hold up best in an up rates environment owing to their slightly shorter profile and more current coupon back to the bondholder. Prepayments are less of a consideration given the massive refinancing that has already occurred in the market.
However, the composition of the TBA itself is key here. If the model incorporates newer and longer pools for instance on 30yr 7%s, even as limited issuance says otherwise, then it will hold up better as rates rally than one would intuitively think.
Performance into a rally is split here across the 3 coupons listed, as each offers attributes in their own accord as profiles are intermediate to shorter life to begin with.
The main proponent of this sector is a more current coupon return, as opposed to a duration play as the results bore out. Therefore, little differential is mined setting one against the other.
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