Agency Mortgage-Backed Securities: Weathering the Storm
We expect stable performance amid increased supply and a benign prepayment environment.
Agency MBS performance was negative in the first quarter, driven largely by broad market volatility as rates rose, the yield curve flattened, and spreads widened. The Bloomberg Barclays U.S. MBS index posted a -1.19 percent total return. Yields ended the quarter at 3.30 percent, higher than the previous quarter, while option-adjusted spreads were roughly 4 basis points wider over the quarter. Conventional MBS outperformed GNMA; 30-year MBS underperformed 15-year MBS; and lower coupons underperformed higher coupons. Prepayment speeds declined over the quarter.
Market Volatility and Rising Rates Hurt First-Quarter MBS Performance
Bloomberg Barclays U.S. MBS Index Spreads
Agency MBS yields ended the quarter at 3.30 percent, higher from the previous quarter, while option-adjusted spreads were roughly 4 basis points wider over the quarter.
Source: Bloomberg, Barclays, Guggenheim Investments. Data as of 3.31.2018. The zero-volatility spread measures the spread that an investor will receive over the entire Treasury spot rate curve. LHS = left hand side, RHS = right hand side.
In our view, MBS spreads still have the potential to widen modestly from here, as levels are tight compared to longer-term historical averages, and 2018 net supply is expected to be higher than it has been in recent years. However, carry remains attractive and could absorb most of the expected spread widening. Further, we expect the sector to continue to provide diversification and lower volatility within a broad fixed-income portfolio. We anticipate the current environment of rangebound rates, low volatility, and reasonable valuations relative to credit sectors will result in support for the sector as investors continue to look for opportunities to add high-quality spread assets. Moreover, market volatility and wider spreads in the first quarter validated the sector’s defensive profile. Stable Agency RMBS spreads relative to investment-grade corporate bonds have persisted since early February, resulting in strong performance for Agency MBS compared to the broader aggregate and the corporate subcomponent during the period. Strong sector performance is particularly notable since two of the largest buyers have stepped away recently: the Fed continues to reduce its MBS portfolio, and U.S. banks have not added in the sector.
We continue to favor less negatively convex assets in which either the collateral or structure offers some cash flow stability. Accordingly, we find select subsectors attractively priced in the current environment, including longer-maturity Agency multifamily, better call-protected pools, and some collateralized mortgage obligation structures. We continue to avoid assets such as Ginnie Mae MBS, in which valuations are relatively stretched and may be affected more by the Fed’s policies or change in regulatory regime.
Agency RMBS and CMBS Outperformed the Agg as Credit Sold Off
February-March 2018 Performance
Stable Agency RMBS spreads relative to investment-grade corporate bonds have persisted since early February, resulting in strong performance for Agency MBS compared to the broader aggregate and the corporate subcomponent during the period.
Source: Bloomberg Barclays, Guggenheim Investments. Data as of 3.31.2018.
—Aditya Agrawal, CFA, Director; Louis Pacilio, Vice President
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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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