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 9/23/22

The phrase “Don’t fight the Fed” was first introduced in the 70’s (a lovely time for inflation lovers) and for most of the last few decades, the phrase meant that the Fed has the market’s back and investors are rewarded for keeping their feet on the gas pedal as the Fed injects liquidity, dampens volatility, and drives outsized returns. But fighting the Fed cuts both ways, and Fed officials are now intent on taming prices, even though the economy is already in a technical recession. Investors have been forced to consider their positions accordingly.

MBS Weekly Market Commentary Week Ending 9/16/22

There are the unfortunate costs of reducing inflation (higher interest rates, slower growth, and softer labor market conditions) that will bring some pain to households and businesses, but a failure to restore price stability would mean far greater economic pain. Markets have interpreted recent Fed comments as: “We are going to raise rates higher and keep them there longer than the market is anticipating. People now understand the seriousness of our commitment to getting inflation back down to 2%. If we have a hard landing and cause a recession, so be it.”

MBS Weekly Market Commentary Week Ending 9/9/22

This year’s run up the coupon stack has led to the destruction of both purchase supply and refinance demand, which has drastically reduced prepayment activity. The Fed’s QE4 created a refinance bonanza in 2020 and 2021, but with the Fed leaving the MBS purchase space next week for the foreseeable future, that party is over. The MCT Review this week examines August prepayment speeds that were released yesterday and what to expect for the remainder of the year.

MBS Weekly Market Commentary Week Ending 9/2/22

In addition to raising the overnight Fed funds rate, the Fed is exiting the MBS and security purchase space as it wraps up QE4. The Fed will reduce its asset holdings by not reinvesting the funds received from maturing securities into new securities as it has been doing over the past two years. The MCT Review this week examines the Fed’s plans and the ultimate impact on a volatile bond market.

MBS Weekly Market Commentary Week Ending 8/26/22

This week’s commentary discusses market preparation and reaction to Fed Chairman Powell’s speech in Jackson Hole. As the Fed puts the brakes on the economy, the central bank is willing to let unemployment go up as a trade for getting inflation under control. Rate hikes are expected to continue as the Fed prioritizes driving down inflation rather than economic growth. Read the rest of this week’s market commentary for more information on the Fed and the MBS market.

MBS Weekly Market Commentary Week Ending 8/19/22

Every week the mortgage industry has new headlines. This week saw talk of Wells Fargo scaling back its mortgage division (possibly greatly exaggerated), MBA mortgage applications dropping to a 22-year low, and U.S. retail sales resiliently remaining flat despite a drop in gasoline prices, though the biggest story was Ginnie Mae and FHFA releasing jointly updated seller/servicer requirements.