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BofAML stays long on CMBS, Agency MBS

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Bank of America Merrill Lynch analysts remain bullish on agency mortgage-backed securities and commercial MBS, despite the recent rise in interest rates and overall rate volatility. "The themes of incremental yield and benign prepayment and supply dynamics, along with a view that rates and volatility are near the high end of the range, lead us to maintain an overweight of the sector," analysts said in the investment giant's weekly securitization overview. BofAML also said further CMBS spread compression is possible upon more improvement in the economy that takes a cue from the rates market. And analysts expect interest rates, which have begun to climb out of previously uncharted depths, will remain "range-bound" over the next few months, "while prepayments will be muted and supply pressures low." The analysts' overweight recommendation continues to lean toward opportunity in MBS in the "up-in-coupon." BofAML said it's "hard to argue that higher inflation expectations drove rates higher," which has been bounced around by more than one. Analysts said rates should have rallied last week instead of selling off as increased risk from the problems in Ireland arose. But higher growth expectations following the start of the Federal Reserve's bond buying, aka QE2, led to the rate volatility that ultimately pushed rates higher. Still, analysts don't foresee growth expectations moving higher, while rates and rate volatility move modestly lower. "Any move higher in rates would signal to banks that building out lending capacity would not be prudent, as already muted refinancing business would slow further," the analysts said. "On the housing side, the issue of 6 million delinquent mortgages, with more looming, [will] keep downside risk to home prices high." For agency MBS, BofAML expects less supply due to the runoff of the Fed's portfolio. The central bank has indicated it plans to reinvest maturing MBS into long-term Treasury securities instead of back into MBS. Analysts also project less mortgage origination for both purchases and refinancings as rates move higher, and a steepening of the curve. BofAML analysts maintain an underweight recommendation for asset-backed securities because "spread and return potential is too low relative to alternatives." Write to Jason Philyaw.

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