As Fed pauses, mortgage bonds look cheap to fund managers

As the Federal Reserve appears to be getting closer to ending its tightening cycle, asset managers such as American Century Investments and Saba Capital Management are buying up mortgage bonds for profits.

Bonds surge in November Latest U.S. Consumer Price Index The report showed that overall prices were basically unchanged from last month, which means that the Federal Reserve may be close to controlling inflation. Investors have been worried for weeks that interest rates would remain higher than expected for longer, but now debt markets are ramping up bets that rates will be cut next year.

Uncertainty about future yield rate changes tends to be a boon for mortgage bonds. But while high-grade corporate bond spreads are near their tightest levels this year, mortgage bonds still look cheap by at least some measures.

The spread on Fannie Mae’s current coupon bonds, a proxy for mortgage bonds currently being created, is about 159 basis points, or 1.59 percentage points higher than a mix of 5-year and 10-year Treasury notes. This is well above the 10-year average (about 1.59 percentage points). 106 basis points, although spreads have narrowed by about 30 basis points since the end of October.

“We do think rates are going to come down and that’s going to be a tailwind for the MBS market,” said John Lovito. “From a spread perspective, they’re close to historical ranges, which is one of the reasons we’re increasing rates.” “The global fixed income co-chief investment officer of American Century Investment Company said in an interview at the beginning of this month. “We have been overweighting stocks over the last three to four months and we will continue to be overweighting stocks.” 5-10% above the benchmark. “

Goldman Sachs Group Inc. said mortgage-backed securities offer an attractive way to earn income as uncertainty about U.S. interest rates declines. Janus Henderson is aggressively shifting capital away from corporate bonds, particularly junk bonds, to increase its mortgage bond allocation, which accounts for one-third of fixed assets in its multi-sector income fund.

“Agency mortgages are very attractive, with valuations at their lowest levels in more than a decade. We think they are fantastic and the prepayment risk is virtually non-existent,” said Phillip Gronniger, client portfolio manager for fixed income strategies. Janus “Even if spreads don’t tighten, you’re still going to get good yields,” Janus Henderson, the investment bank’s investment bank, said in an interview earlier this month.

One reason for the wide spreads: Bank of America, traditionally one of the largest buyers of MBS, recently exited the market as deposits fell earlier this year. Banks typically fund their investments with deposits.

Another major buyer of the security is also reducing its holdings. The Fed was the biggest buyer of mortgage bonds during the latest round of quantitative easing, but has effectively stopped buying them, Reduce securities investment portfolio.

But even as demand shrinks, MBS now has a key positive, namely Mortgage rates have risen so much in the past two years Sonal Desai, chief investment officer of fixed income at Franklin Templeton, said even if interest rates fell slightly, few borrowers would have an incentive to refinance. Sonal Desai, chief investment officer of fixed income at Franklin Templeton, said the risk of consumers paying off their mortgages early is currently low. Prepayment returns principal to investors When yields fall, the return on the security will decrease.

“Putting these factors together, we are quite optimistic about the mortgage market. We are overweight,” Desai said.

In a note this month, Morgan Stanley strategists including Serena Tang and Vishwanath Tirupattur said the bonds have the potential to perform well. MBS spreads reflect currently weak market sentiment, which could become more positive by the second half of next year, leading to modest returns. Securities spreads tightened, strategists wrote.

Already performed well

Some of the outperformance expected by bond fund managers has already occurred. MBS broadly rose 4.2% between November and Friday, while U.S. Treasuries gained 2.6%, according to Bloomberg Index data.

The rally in mortgage bonds may be a relief to at least some bond fund managers who already hold large holdings of such securities in their portfolios. Analysts say fund managers are under pressure to trim some holdings of mortgage-backed securities as U.S. Treasury yields rise. Citigroup said in an October 6 report.

But there is still room for bonds to continue to perform better, said Boris Peresechensky, portfolio manager at Orange Investment Advisors. He said bank deposits were showing signs of leveling off, removing at least one barrier to bank purchases.Reserve Report on Friday It said that after seasonally adjustment, deposits grew at an annual rate of 0.1% in October.

Boaz Weinstein, founder of Saba Capital, said the securities look cheap compared with some companies.

“Most ‘experts’ say the Fed is over, and the agency MBS or BBB businesses are begging for closure,” Weinstein said. wrote Last week, on X (the platform formerly known as Twitter), “I opened it and the size was fine.”

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