With the economy improving, most investors understand this means the Federal Reserve’s bond-buying program will eventually come to an end.
This should not come as a surprise since the central bank has signaled eventual tapering. However, rising agency mortgage-backed securities yields will pressure yields higher across all credit products, according to JPMorgan Chase.
"We expect to see the risk premium between prime/subprime floaters to compress. The nature of this move higher in rates should benefit bonds levered to the housing market recovery more," said JPMorgan (JPM) analysts John Sim, Abhishek Mistry and Nabeem Hashem.
Federal Reserve Chairman Ben Bernanke commented on how the housing market may be strong enough to withstand higher borrowing costs and how the economy is improving, during a conference last week.
As a result, nonagency MBS investors should note that the housing market is supporting economic growth and creating jobs.
Additionally, rising home prices increase household wealth and support consumption spending and consumer sentiment.
Furthermore, unemployment levels should continue to improve, meaning the central bank’s open-ended third round of quantitative easing program will begin to wind down sooner rather than later.
For instance, state and local governments that have been a major drag on the economy are now coming into a position where they no longer have to lay of large numbers of workers, the report said
"We think the reaction to the Fed announcement is overdone. The better economic prospects should imply tighter credit spreads, benefiting legacy paper," JPMorgan analysts noted.
As a result, fundamentals have not changed, if anything they have actually improved.
Thus, investors believe that home prices will be up somewhere between 5% and 10% in 2013. Additionally, investors believe the number of existing home sales will hit 5.18 million this year.
"We view the overall weakness in the sector to be a buying opportunity and expect new issue spreads should be back in the context of 200 over swaps when the dust settles (albeit at slower pricing speeds)," JPMorgan analysts added.