The lull in April’s volatility proved to be the calm before the storm, particularly in agency mortgage-backed securities, analysts suggested.

Thus, investors should take advantage of the agency MBS weakness, but remain cautious on derivatives and specified where housing strength and policy risk is eroding prepayment reduction, according to Bank of America Merrill Lynch’s latest report.

“We remain constructive on credit for the medium to long term but cautiously tactically. The price rise of the past few  weeks was a little too fast,” said MBS strategists Chris Flanagan and Adam Katz for Bank of America Merrill Lynch (BAC)

Over the past year, rates that move higher — as the market mood swings on the Federal Reserve’s open-ended third round of quantitative easing expectations — have typically been accompanied by moves higher in rate volatility.

Naturally, a shift in expectations about the end date for QE has not been kind to current coupon agency MBS.

For instance, the Fannie-3 coupons have been hit particularly hard since the start of the month.

However, this week, analysts for BofAML moved back to an overweight of the agency MBS basis, primarily because the concerns about an early Fed exit, the rate selloff and the weakness in MBS were all overdone on a short-term basis. 

“As we said in our 2013 outlook, successfully trading these short term ranges is likely to be the driver of alpha this year in agency space,” according to the analysts.

Overall, the topic is one of staying the course with two main themes for 2013, including that the housing recovery will continue to be strong and contribute to broader economic recovery, but that the central bank will remain vigilant on QE3.

Also, investors should err on the side of excess accommodation and persistence, due to the weakness in the labor market. 

“These themes will clearly work to the advantage of residential and commercial mortgage credit and, keeping in mind our near term caution on entry points, lead us to continue to recommend an overweight of these sectors,” according to BofAML analysts.

In agency MBS, the picture is more nuanced and valuations should continue to fluctuate as the two themes play off one another. 

Meanwhile, on prepayment protection stories — whether it’s policy risk or home price recovery risk — the secular opportunity of the past few years is winding down.

“There may be opportunities to trade short term dislocations but, as we discussed last week, most of the policy arrows in DC are pointing in the direction of finding ways to refinance as many legacy borrowers as possible,” they analysts explained. 

They concluded, “Being nimble and trading around policy landmines in a market that is not exceptionally liquid likely will prove difficult. As with our view on specifieds, we recommend caution.”

Most Popular Articles

Former Fannie Mae employee gets 6 years in prison for making $1 million on shady foreclosure sales

A former Fannie Mae employee will spend more than the next six years in prison after being found guilty of accepting more than a million dollars in bribes and kickbacks in exchange for selling Fannie Mae-owned foreclosures for less than market value.

Jan 15, 2020 By
3d rendering of a row of luxury townhouses along a street

Log In

Forgot Password?

Don't have an account? Please