2023 February: Rising Vols/Rates Erodes Gains, Dormant Stack Beholden To Rallies
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By Albert Durso, Senior RMBS and CMBS Strategist, Yield Book
U.S. Agency Mortgages slumped after a promising start to the new year, as rising Vols detracted from embedded call structures like MBS. Supply ticked up above recent month levels, providing headwinds against production coupons while lower coupons are completely dependent on rates rallies and “mark to market” pricing as trading is fleeting there.
Volatility is a huge component in MBS performance and the tale of the tape can be read daily in 3m10Y Vols (historically a suitable proxy for MBS). That tenor rose higher 13% on the month to 115.40, taking mortgage hopes lower. Longer tenors, namely 5Y10Y and 1Y10Y were modestly changed overall but did experience a rise from the lows at mid-month.
U.S. 10yr note yields rose 53bps to 3.93%, while the 2s/10s curve inverted yet another 16bps to -87.30. MBS Index results gave back 31basis points overall to Treasuries, while both remain heavily underwater two months in at -231bps+.
Originator supply increased another 17% from last month to $2.17 billion per day, with borrowers locking against the fear of even higher rates. The 30yr primary rate rose 52bps to 6.65% (FHLMC PMMS), while Bankrate’s daily quote spiking above 6.95%. Current coupons continue to be focused on 30yr 5%s and 5.5%s (74.7%), with the wings of the coupon stack (7%s and 4%) now less than 1% of the output.
Into the selloff/spread weakness, Relative Value accounts bought outright, while Banks and Hedge Funds sought lower prices in general. Money Managers were UIC (Up in Coupon) movers at mid-month, while Asia was relatively tame.
The FHA cut the annual Mortgage Insurance Premium (MIP) rate 30 basis points in a somewhat long overdue move to expand lending to first time home buyers and FHA borrowers. It is unlikely this MIP cut will have a material effect to borrowing versus a backdrop of higher rates.
Lastly, prepayment speeds on agency MBS fell again in last month’s recap, down 17% along UMBS and 18% in GNMA space.
Market Perspective- Where the Coupon Stack is Concentrated
MBS issuance has taken a nosedive the past year plus, as rising rates, falling refinances and limited repeat business has shrunk originations. With the Federal Reserve no longer minding the store on asset purchases (mortgages especially), QT has replaced QE with the battle against inflation of primary importance.
The bulk of production was derived in the last leg of QE, when the onslaught of Covid 19 forced the Fed back on the buyback program (May 2019). 10yr T-note rates plunged from 2.60% to a 2020 low of 0.53%, while 30yr mortgage rates went from 4.17% to 2.65%. Since that time frame, we have retraced higher +260 to +330 basis points along MBS and Treasuries.
A look at the resulting production showed a refinancing wave where the upper stack was obliterated and replaced by lower coupons, en masse.
From the chart below, the predominance of lower coupon 30yr 2%s and 2.5%s is plainly evident. The Current Face, or RPB, is presently at 52.3% of the approximately $8.4 Trillion in Agency MBS. Logically, with those average note rates hovering between 2.75% and 3.318% respectively, it makes sense that refinancing is out of the question as a turnover source. Similarly, 93.5% of the universe is contained in net coupons from 2% to 4.5% with the higher coupons note rate averaging 4.98%-well below the current Freddie Mac PMMS reading of 6.50%.
This stack entrenchment has held the index performance hostage to rates rallies and mark to market outcomes, with little to no trading down in the bulk of MBS Outstanding. Current and production coupons are prey to originations but, their overall impact upon performance is immaterial, percentage wise.
MONTH TO DATE: Spreads and levels mirrored the move in rates, with both fading and softening into month end, after a poor finish to January 2023. The 30yr current coupon (par-based UMBS CMM) rose 86 basis points (5.73%), OAS softened 19bps to 31.4, ZV measures wider 27bps to 142.1 and the closely followed correlation to 5&10yr Treasury blend gapped 19bps to 144.7.
Year to Date: Things have evened out for the first two months, with results fairly muted for now. 30yr CC levels are up 39bps, OAS wider 21bps, ZVs wider 11bps, and vs. the 5&10yr treasury blend +6bps.
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