/perspectives/sector-views/agency-mbs-a-patient-approach-to-agency-mbs

Agency Mortgage-Backed Securities: A Patient Approach to Agency MBS

The sector looks attractive given wide spreads and the nearing inflection point in the hiking cycle.

November 20, 2023


This Agency Mortgage-Backed Securities sector report is excerpted from the Fourth Quarter 2023 Fixed-Income Sector Views.

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.

Residential MBS Appears Attractive Relative to Commercial MBS

Cumulative Excess YTD Returns Relative to U.S. Treasurys

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 outperformance.

Residential MBS Appears Attractive Relative to Commercial MBS

Source: Guggenheim Investments, Bloomberg. Data as of 9.30.2023.

—By Louis Pacilio

 
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This material contains opinions of the authors, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein are subject to change without notice. Forward-looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.

Investing involves risk, including the possible loss of principal. Investments in fixed-income instruments are subject to the possibility that interest rates could rise, causing their values to decline. High yield and unrated debt securities are at a greater risk of default than investment grade bonds and may be less liquid, which may increase volatility. Investors in asset-backed securities, including mortgage-backed securities and collateralized loan obligations (“CLOs”), generally receive payments that are part interest and part return of principal. These payments may vary based on the rate loans are repaid. Some asset-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 and valuation risk. CLOs bear similar risks to investing in loans directly, such as credit, interest rate, counterparty, prepayment, liquidity, and valuation risks. Loans are often below investment grade, may be unrated, and typically offer a fixed or floating interest rate.

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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.

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