By Isobel Kennedy
NEW YORK, (MNI) – The agency mortgage-backed securities market
remains on fire Friday in continued reaction to the Federal Reserve’s
recent actions but some caution flags have also been raised.
The current coupon 30-year MBS hovers near the highs of day and is
yielding 1.84% vs. yesterday’s close of 1.90%. The spread to a blend of
5-year and 10-year Treasuries is +61 basis points vs. +68 yesterday.
Sources report that some shorts are finally getting stopped out
amid better real money buying from banks, money managers, fast money and
REITs across the stack.
The Fed, of course, continues to buy each day and origination
selling has been relatively light at under $2 billion Friday.
The market began doing better the moment the Fed announced on
September 13 that it would be buying $40 billion agency MBS per month
with no end date mentioned.
This comes on top of the $37 billion of MBS buying the Fed must do
from September 14 to October 11 because of the prepayments it receives
monthly on its $844 billion agency MBS portfolio.
The market got an extra goose higher late Thursday when the Fed
announced it bought $17.5 billion agency MBS in the week ended September
19. Those purchases seemed to be about equally split between new QE3
buys and regular weekly prepayment reinvestment buys.
But the market has come a very long ways and a degree of caution
has set in. The 30-year MBS rate was at 2.36% before the Fed’s
announcement on September 13. The spread to the Treasury blend stood at
+113 bps.
In order to buy $17.5 billion agency MBS, the Fed bought every
coupon, name and maturity available. It bought Fannie Maes, Freddie Macs
and Ginnie Maes. It bought 15-years and 30-years. It bought 2.50%, 3.00%
and 3.5% coupons for delivery in October, November and December.
The market took note Friday that the Fed had bought a surprising
number of Fannie Mae 3.50% coupons.
The mortgage strategy team at Credit Suisse late yesterday advised
clients to sell Fannie 3.5s and receive in 10-year swaps.
“The cumulative outperformance of FN 3s and 3.5s vs. rates has
surpassed last week’s levels following Thursday’s release of Fed’s
month-to-date purchases in September,” Credit Suisse said in a research
note.
“We favor selling FN 3.5s to express this view due to our
expectation that Fed purchases should decisively tilt towards FN 3s, at
current rate levels,” Credit Suisse said.
Credit Suisse admits “the onerous negative carry makes it a
challenging trade. However, we believe risk/reward is favorable given
extreme valuations and potential for profit taking near quarter-end.
Continued aggressive buying of FN 3.5s is a key risk to this trade, in
our view.”
The strategy team at BNP Paribas thinks heavy demand from the Fed
for MBS in the face of negative net MBS issuance will allow them to
further outperform Treasuries and that “riskier asset classes,
particularly corporate bonds, with their similar credit quality and
liquidity, are likely to do even better.”
Global debt investors that use benchmarks “will face asset
shortages in the face of this QE-induced contraction in available
investment grade assets. This is expected to provide technical support
to US IG credit despite low yields and historically full valuations, and
will help to perpetuate the current strong demand for high quality new
issue paper. High yield and emerging markets credit also benefit from
this dynamic,” BNP said in a research note.
For reference, this is what the Fed announced on September 13:
— To make open ended purchases of agency MBS each month totalling
$40 billion; From September 14 to September 30, the pro rated amount is
$23 billion;
— To make purchases totally $45 billion each month in the Treasury
market until the end of December. This is an extension of their Maturity
Extension Program, or Operation Twist as the Street calls it, where the
Fed sells shorter dated Treasuries and buys longer dated Treasuries. The
Fed said all its programs will be analyzed at the end of the year so the
future of MEP is not clear at this point;
— Fed will continue to buy agency MBS each month with the proceeds
of prepayments made to its approximately $800 billion MBS portfolio.
Each month the Fed tells the markets how many prepayment related
reinvestment purchases it intends to make. They have been running as low
as $25 billion a month to as high as $37 billion a month recently;
— Fed said it expects its low rate policy to stay in effect until
at least the middle of 2015. It had been until at least the end of 2014
previously.
** MNI New York Newsroom: 212-669-6430 **
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