/perspectives/sector-views/agency-mbs-fed-leads-the-way

Agency Mortgage-Backed Securities: Fed Leads the Way

Fed stabilizes MBS sector despite record low mortgage rates.

March 11, 2021


This Agency Mortgage-Backed Securities sector report is excerpted from the First Quarter 2021 Fixed-Income Outlook.

Mortgage spreads continued to tighten over the fourth quarter as the Fed and heavy bank demand offset prepayment concerns due to mortgage rates hitting all-time lows. Option-adjusted spreads ended the quarter at 41 basis points, 22 basis points tighter quarter over quarter and effectively unchanged year over year.

Fed Intervention Helped Stabilize Mortgage Spreads

Bloomberg Barclays Agency MBS Index OAS

Option-adjusted spreads ended the quarter at 41 basis points, 22 basis points tighter quarter over quarter and effectively unchanged year over year.

Fed Intervention Brings Stability to Mortgage Spreads

Source: Guggenheim Investments, Bloomberg. Data as of 12.31.2020

The Bloomberg Barclays U.S. MBS Index fourth quarter total return and excess return were 0.22 percent and 0.34 percent, respectively. Agency MBS 2020 total returns totaled 3.84 percent, which lagged all other subsectors of the Bloomberg Barclays U.S. Aggregate Index. Notably, Agency CMBS—which offer better convexity and capped issuance—posted fourth quarter and 2020 total returns of 0.50 percent and 8.92 percent, respectively.

Since the start of QE4, mortgage spread performance has been bifurcated between production coupons buoyed by over $1 trillion in Fed purchases and “non-Fed” coupons exposed to primary rates at all-time lows.

Historically Low Mortgage Rates Boost Agency MBS Relative Performance

Since the start of QE4, mortgage spread performance has been bifurcated between production coupons buoyed by over $1 trillion in Fed purchases and “non-Fed” coupons exposed to primary rates at all-time lows.

Historically Low Mortgage Rates Boost Agency MBS Relative Performance

Source: Guggenheim Investments, Bloomberg. Data as of 12.31.2020

Fed purchases remove the most negatively convex bonds and boost the carry profile of “to-be-announced” (TBA) securities, which has resulted in the outperformance of lower coupons versus the mortgage index. Given the small percentage of the index that lower coupons comprise and the Fed’s stated intention to continue with $40 billion of monthly net purchases, this is a trend we expect to continue. Primary rates remain near all-time lows at well below 3 percent despite the recent rates selloff, leading call-protected subsectors of the market, including specified pools and Agency CMBS, to enjoy some of their best relative performance in recent memory. Heading into 2021, we expect heightened prepay concerns to remain as mortgage originators increase capacity to meet demand and capitalize on record profitability.

Against this longer-term outlook, we favor investments where either the collateral or structure offers some cash flow stability. We find select subsectors—especially those not directly purchased by the Fed—attractively priced in the current environment, including off-the-run Agency CMBS, select specified pools, and locked-out collateralized mortgage obligation structures. These investments enjoyed strong performance prior to Fed intervention, and we expect similar results when the Fed eventually reduces the pace of its Agency MBS purchases and the market's focus returns to cash flow fundamentals.

—Aditya Agrawal, CFA, Director; Louis Pacilio, CFA, Vice President

 

Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.

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©2021, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.


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