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Banks Likely Getting Back into 'Attractive' Agency MBS Purchases

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The defensive strategy of banks to buy Treasuries and short-duration cash products, thereby largely avoiding the mortgage-backed securities (MBS) market until spreads widen, is not paying off according to Barclays Capital. As a result, banks will likely get back into purchasing MBS with the promise of higher yields in the products versus Treasuries, at a time when investment in the space is growing attractive. In a note by Barclays analyst Derek Chen, the move may already be happening. "The biggest 25 banks added an impressive $51.4bn during the latest two weeks (ending July 21), the largest jump in 18 months," he wrote in a research released today. "If further data confirm this as the start of a renewed bank bid for MBS, which traditionally has been one of the biggest sources of demand for MBS but has been on the sidelines for a while now, it should bode very well for the agency MBS basis," he said. Deutsche Bank structured finance analyst Steven Abrahams said that at current levels, 15-year agency paper looks "attractive" versus 30-years in a couple of coupons, "although investors do take on some risk if the yield curve flattens sharply or volatility drops." Banks are historically big buyers of MBS and have the potential to absorb another $150bn of agency mortgages. In the midst of the passage of Dodd-Frank, banks fled to Treasuries, while parking cash in short-duration. This is an expensive strategy, and now that reform is passed, the banks are looking for yield. Coupled with the Fed withdrawal from MBS purchases, and yields trending lower and spreads tightening, Banks will likely push back into the market, Chen adds. Write to Jacob Gaffney.

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