U.S. MBS Agency Performance July 2022: Rebound Led By Lower Coupons

By Albert Durso, senior RMBS and CMBS strategist, Yield Book

The U.S. MBS agency market had another bounce-back outing in July, alternating good and bad months since the start of 2022. This time, however, the sector employed a slightly different formula owing to the preponderance of lower and discounted coupons that still dominate MBS market share.

For the month, the MBS index gained +183bps versus the riskless Treasury index, and +121bps spread advantage. The main stack gainers were lower 30yr 1.5%s through 3.5%s, with belly 4%s about flat, and fuller 4.5%s and above losing the most as rates rallies run contrary to shorter duration premiums.

The macro backdrop revealed that the 2s/10s curve inverted -28.20 bps, 10yr notes ultimately flattened 23.5bps net (to 2.65%), with 3m10y vols easing 7.1bps to 110.5. The Federal Reserve meeting at month’s end saw another +75bps move higher on interest rates with more forecast into year-end.

Flows on the month had supply lower at $2.7b per day, with rates rallies mixed in serving to sporadically spike totals above that. Most borrowers are well out of money and originations have receded against the backdrop of higher lending rates and a somewhat peaked housing market.

Fed buying has reset to $600mm per day via the most recent MBS Ops schedules ($6B bi-weekly), while the outperformance of the stack was fueled by money managers buying lower 2%s through 3.5%s. A flattening yield curve necessitated those duration grabs. Real money accounts require a somewhat calmer setting (less volatility), and Asian investors (longtime supporters of GNMAs) are quiet as the U.S. dollar continues to trounce all other currencies.

Dollar Roll star performer this past month was no doubt the G2 5.5% roll (Jul/Aug) soaring to +30/32nds on 48hr day, lowering financing (sellers of the roll) to an incredible -706 basis points! This definitively underscored the lack of front month MBS production in higher coupons and the plight of sellers to navigate actual delivery against their short positions.

For the month of July, the current coupon (par based) fell -55.2 basis points to 3.79% as rates rallies continue to be fueled by recession fears and curve inversions supporting those worries. Spreads firmed across the board, feasting on prior month wides as we see-saw month to month. OAS measures narrowed -24.2bps, ZV spreads -29.2bps and 5&10yr tsy blend comparisons -23.7bps.

Year to date, spreads are wider and the coupon higher in reflection of the general tone of inflation and Fed interest rates move; from the chart below; Current coupon +174bps, OAS +21.2bps, ZV +43bps, and 5&10yr blend comparisons +45.2bps.

Year over year (July 21 to July 22), the picture is even more dramatic as you can see rates had ground at or near all-time lows and spreads ultimately reversed course after a feeding frenzy had left little to the investor in a competition for investment dollars last summer.

In a nod to this month’s duration plays, we refocus our attention to the bulk of the MBS complex (30yr 2%s, 2.5%s), while including fuller and more current 4.5%s too. Below is the table of UMBS TBA coupons and their response to a curve shift in 100bps intervals.

In both scenarios (+/- 200bps), UMBS/FNMA 2%s fare the best, keeping a longer duration into any rally and not extending that much more into a sell-off. In addition to the outperformance, there are a plethora of bonds out there as a percentage of the tradeable float.

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