Mortgage Strategy Monthly Report

Walt Schmidt, and Alexis Vilimas
Pulling the Right Levers

There has been a good deal of uncertainty regarding both rates and the MBS basis for some time now. The market “feels” cheap vs. the UST benchmark already, but it may have the potential to get cheaper. This month, we look at the basis over a longer-term historical perspective and through the lens of two of the three major levers one can pull in fixed income: duration/curve, volatility/optionality and credit.

The Reality of Mortgage Assumptions

In the most unaffordable housing market since the 1980s, borrowers are eager to read any headline that promises lower mortgage interest rates. Fintech startups have recently proposed assumable mortgages as an avenue for homebuyers to access below-market interest rates. The following analysis will define assumable mortgages and estimate their impact on MBS prepayments.

Market Update

The MBS index sits at negative 42 basis points for the month in excess return and is down 1.2% for the month in total return. The coupons in the 30yr conventionals have had a noticeable consistency in performance, between negative 25 and 50 basis points in excess return across the 30yr conventional coupon statck. Activity in the Hybrid ARM and CMO markets has picked up since our September publication, but there has been relatively little movement in Hybrid ARM spreads in October. Month-to-date, the 10x6mo sectors saw spreads tighten by 5bps on both the 4.5 and 5.0 coupon stacks; Floater spreads for the 7.0 Passthrus tightened by 10 bps. The MBA Purchase Index currently sits at 137.5, which is the new 52-week low for the index. We expect the 52-week low for the purchase index to be continuously retested as long as rates remain in the current range.

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