MBS Weekly Market Commentary Week Ending 5/6/22

The main headline from the bond market this week was the Federal Reserve raising interest rates 50 basis points, as expected, and announcing it will begin allowing its holdings of Treasuries and mortgage-backed securities (MBS) to decline in June. The initial combined monthly pace will be $47.5 billion, stepping up over three months to a monthly total of $95 billion: $35 billion of MBS and $60 billion of Treasuries. 

The question now becomes whether the central bank will engage in active MBS sales to reach its $35 billion roll off cap. Neither the statement nor the balance sheet plan repeated the goal of returning the nearly $9 trillion balance sheet, $2.73 trillion of which is agency MBS, to all Treasuries. There was no mention about the potential for active MBS sales, so it appears unlikely. Talk of active MBS sales had increased volatility in the MBS market recently.

MBS roll off is expected to drop to around $25 billion per month by July, and by the time the $35 billion maximum cap is instituted in September, the Fed’s portfolio roll off will likely be well below that level, as the overwhelming majority of American homeowners have no incentive to refinance with current 30-year lending rates around 5.5%. Even still, roll off should add more than $150 billion in additional supply through year end that private investors need to take down. 

Letting some of these assets run off isn’t necessarily as easy as it sounds. The last time the Fed tried to shrink its balance sheet, it caused havoc in the repo market. Hedge funds that were looking to exploit minute mispricings in the Treasury market borrowed heavily to fund basis trades, but the stability of the financial system was threatened when repo rates – the hedge funds cost of borrowing – spiked. The Fed ended up extending emergency loans and ended balance sheet reduction. 

This iteration of the Fed has been highly dovish for over 10 years, and though “the Committee is prepared to adjust any of the details of its approach to reducing the size of the balance sheet in light of economic and financial developments,” it’s hard for a leopard to change its spots. Over those past 10 years, the combination of low mortgage rates and a relatively flat yield curve has allowed mortgage lenders to enjoy low TBA roll costs. The recent rapid rise in mortgage rates have caused the new market coupons to have substantially higher roll costs. 

As we’ve moved to higher coupons, we have substantially higher rolls (~44 basis points per month). This increases the typically assumed hedge cost of 1 basis point per day to around 1.7 basis points per day. TBA spreads have been extraordinarily wide for the past couple of weeks, with some coupons experiencing a half point bid / ask spread. Bid-offer spreads have widened to 8-10 basis points for low market coupons and go higher as you move up in coupon.

When hedging to match expiration, this means extensions that cause a roll are exposed to both the higher costs and the wider bid offer spread. The prevailing notion of extensions as a profit center in recent years has been reversed. MCT recommends taking a hard look at your extension policies and ensuring fees cover increased costs. Consider the liquidity of your production down the road based on expiration, and leverage AOT delivery where possible to avoid wide bid-offer spreads.

10-Year Treasury Yield Curve

Compare this chart with the mortgage rates chart to see how the 10-year treasury and mortgage rates are correlated. Read more below to learn how mortgage rates are tied to the 10 year treasury yield. View raw data on U.S. Department of the Treasury website.

 

Mortgage Rates Today

The current MBS daily rates are shown below in this chart for 5/1 Yr ARM, Jumbo 30 Yr, FHA 30 Yr, 15 Yr Fixed, 30 Yr Fixed. Sign up for our MBS Market Commentary to receive daily mortgage news in your inbox.

About the Author

Robbie Chrisman, Head of Content, MCT

Robbie started his mortgage industry career with internships during high school and college at Peoples National Bank in Colorado, and RPM & Bay Equity in the San Francisco Bay Area. After graduating from The University of Texas at Austin with a degree in Finance in 2014, he went to work at SoFi, where he rose to Director, Capital Markets assisting in the creation of SoFi’s residential mortgage division before leaving to work for TMS in Austin, Texas. From there, he went to work for FinTech startup Riivos in San Francisco and now is the Head of Content at Mortgage Capital Trading (MCT) in San Diego.

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Previous Weekly Market Reviews by Mortgage Capital Trading (MCT)

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MBS Weekly Market Commentary Week Ending 3/31/23

The market reaction went a little “too far, too fast” in regard to the Fed policy pivot. We witnessed the coupon stack (i.e., the price spread between TBA coupons) decompress in more than a trivial manner in a short period. However, the primary mortgage market has been largely reluctant to follow the Treasury rally, and mortgage rates have ultimately not dropped by the same amount as Treasury yields.

MBS Weekly Market Commentary Week Ending 3/24/23

The FOMC raised its benchmark rate by 25 basis points to a new range of 4.75%-5.00% on Wednesday, a middle ground policy move made in the hope of tampering inflation without further harming the banking system. The raise marks the 9th consecutive rate hike since the Fed began hiking in May of last year and brings the target fed funds rate range to the highest level since September 2007. While the central bank’s monetary policy has been aimed at correcting inflation, it has also revealed hidden weaknesses (e.g., entities whose balance sheets relied on low interest rates).

MBS Weekly Market Commentary Week Ending 3/17/23

Next week will reveal the Fed’s resolve on continuing to beat the drum on their aggressive inflation fight. The word until now has been that the central bank will keep hiking interest rates until inflation is under control.

MBS Weekly Market Commentary Week Ending 3/10/23

Events this week likely will lead to a higher peak interest rate than investors had been expecting just weeks ago. Central bankers appear worried about a cycle in which workers seek higher pay to offset inflation’s bite, and in turn trigger more price increases. In fact, inflation remains high because people have jobs and earn enough income to cover stubbornly expensive housing costs. Robust hiring is good for the economy and workers, but elevated pay growth puts added pressure on the Fed to bring down earnings. 

MBS Weekly Market Commentary Week Ending 2/10/23

The week after the jobs report is generally pretty data-light, and this week was no exception. With a dearth of data, market movement hinged on “Fed speak” and consumer sentiment. We saw some volatility return to bond markets as investors built in expectations for a more hawkish Fed. As a reminder, the Fed raised its benchmark rate last week to a range of 4.5% to 4.75%. Let’s run through what we’ve learned in the wake of that decision and a robust U.S. payrolls report that took some wind out of investors’ sails that had hopes for rate cuts by summer.

MBS Weekly Market Commentary Week Ending 2/3/23

As strong as economists may have thought the job market was, it’s even stronger. In addition to headline non-farm payrolls in January (517,000) beating estimates by around 300,000, employment numbers were revised higher for the past two months. Yes, a tight labor market is anathema to any sort of quick stop to the Federal Reserve’s rate hiking cycle, but the growth rate in average hourly earnings is declining, which will be welcome news to Fed Chair Powell and his colleagues. There exists a raging debate among economists over whether we’ll need a sharp rise in unemployment to keep inflation low.