At the direction of our portfolio management teams, we have continued to generate trade ideas to grow our exposure to Agency RMBS as spreads test multi decade wides. Our preference is for close to current production coupons with discounted dollar prices and attractive convexity profiles. Historically attractive valuations have been driven by both the Fed and banks simultaneously running down their balance sheets and elevated interest rate volatility arising from Fed policy uncertainty. At one point MBS yields were near 6.50 percent, which represents a spread of 180 basis points over similar-tenor U.S. Treasurys, and the highest spreads seen since the Global Financial Crisis. While the Fed’s terminal rate appears within reach, market expectations have shifted to focus on the timing of future easing with “higher for longer” extending the timeline for eventual MBS spread tightening.
In the meantime, the steepening of the yield curve has been a welcome development for MBS, even if it comes alongside higher rates. Curve steepening increases the appeal of the sector versus cash alternatives and decreases the prepayment option cost embedded in mortgage bonds. Over the medium to long term, we look for curve steepening to continue via lower overall rates as Fed tightening weighs on the economy.
We favor residential over commercial Agency MBS. The Agency commercial sector benefitted from both a drop off in supply and lack of Fed selling and has recently outperformed the residential sector. We believe that valuation and operating headwinds facing commercial real estate will test this technicals-driven outperformance. In residential MBS, we favor new-issue passthrough securities due to their wider valuations and higher current yields relative to the low coupons that dominate the Bloomberg MBS Index. With rates testing new highs, these bonds still require 1.00–1.50 percent lower mortgage rates for strong borrower incentive to refinance and also benefit from any prospective normalization in rate volatility as the future path of monetary policy becomes clear. This, layered on top of the superior convexity profile of select specified pools, allows for sector exposure while maintaining a strong degree of cash flow certainty.
Against this backdrop of evolving market conditions, we remain constructive on Agency MBS. Given the strong liquidity and attractive pricing in the sector, investors can afford to be patient as Fed policy plays out and uncertainty around rates drops. Normalization of rate volatility and curve steepening are both positives for Agency MBS due to the embedded refinancing option.
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*Assets under management is as of 3.31.2024 and includes leverage of $14.5bn. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Japan Limited, and GS GAMMA Advisors, LLC.