When it comes to mortgage-backed securities, the months of August and September turned into a tale of two markets, with MBS profits rising at the start of both months before falling in each period, analysts claim.
The first half of August predominately witnessed higher rates, falling prices and continued Federal Reserve tapering concerns.
On the flip side, the latter half of the month saw MBS benefit from elevated concerns over the ongoing debate in Syria, limited convexity hedging and consistent purchases by the central bank, explained Royal Bank of Scotland (RBS) analysts Jeana Curro and Ashley Gam.
Thus far, September is mirroring the split personality of August, with the month opening up at profit highs and unexpectedly falling as payroll numbers shrink.
However, the market enjoyed a solid rally on the news announced this week that former U.S Treasury Secretary Larry Summers withdrew his candidacy for Fed chairman.
"The news has brought back some steady buying from overseas accounts and a general feeling that the next Fed chair will favor a gradual withdrawal of stimulus — most still expect to hear some sort of a tapering announced in Wednesday’s meeting," RBS analysts noted.
Many market analysts pointed out that Summers taking his name off the ballot for the Fed chair made a huge impact on the market because he was viewed as more hawkish on policies, particularly the central bank’s bond-buying program when compared to other possible candidates, including the market favorite Fed Vice Chairman Janet Yellen.
"Even if it’s not Yellen, the other alternates are still a lot better than Summers because it was clear many Fed governors did not want to work with him, which would’ve resulted in a lot of departures off the Federal Reserve Board," explained Compass Point analyst Jason Stewart.
He added, "That’s a lot of uncertainty for the market to handle."
Nonetheless, the interest rate environment is considerably more balanced now than it was in May when the Fed began discussing tapering options.
While the market anticipates that the central bank will propose a change of pace to its quantitative easing bond-buying program, the odds are shifting towards a greater reduction in Treasury activity than agency MBS.
Additionally, the Fed is expected to incrementally slow purchases and allow for holdings to mature rather than initiate sales, Compass Point noted.
"We cannot ignore the secular trend toward higher yields, but believe balance sheet risk has been reduced and see a tactical opportunity in the sector," Stewart stated.
When taking a recent look at agency MBS flows, the top buyers in the past 12 months are the Federal Reserve and mortgage real estate investment trusts, according to Compass Point.
However, mREITs are not raising enough equity to attract investors and the central bank has announced plans to begin tapering its MBS purchases, Stewart stated.
"So who will be the marginal buyer at some point," Stewart concluded. "That’s what the market is going to struggle with in the near future."