JP Morgan Says Sell Mortgage Bonds as Fed Snaps Up Record MBS
The spread of mortgage-backed securities (MBS) bonds yields to Treasuries is tight and likely to remain tight in the near-term, but swap spreads are currently 5-10 bps too narrow to greatly entice private investors, according to a JP Morgan Securities conference call on MBS and asset-backed securities (ABS). While private investors largely hold on the buy side, the government continues to buy up agency MBS as part of its $1.25trn agency MBS-purchase program. JP Morgan researchers recommended selling MBS and buying Treasuries ahead of the Federal Reserve's exit from the $1.25trn agency MBS-purchase program, which will likely spur a widening of MBS spreads to Treasuries. Further the GSEs are expected to reduce portfolio size by 10% yearly going forward (see graph). The New York Fed on Thursday said it bought up $14bn of agency MBS, net of another $14.9bn of MBS sales, in the week ending January 13 from Freddie Mac (FRE), Fannie Mae (FNM) and Ginnie Mae. The weekly purchases bring the running total to nearly $1.137trn of net purchases to date, according to research by JP Morgan (JPM). The weekly purchased bring the Fed's balance sheet to a record $2.27trn in the week ending January 13, from $2.22trn a week earlier. "[A]s we approach the end of the Fed program, mortgages should start approaching the wider levels where private investors will support the market," JP Morgan said in a presentation for the call this week. And while "spreads will reflect [the] post-Fed world," researchers see better relative value in the non-agency or private-label MBS sector. Additionally, prepayment speeds for the mortgage securitization agencies Freddie and Fannie are "highly likely" to increase in coming months as the agencies buyout delinquent pipelines. The US Treasury Department recently raised the agency portfolio caps, giving Freddie and Fannie greater power to clean up delinquent portfolios. JP Morgan researchers see a 3- to 6-month time frame for cleanup most likely, as Freddie and Fannie are likely aware of the significant market impact posed by a significant pickup in agency prepay speeds. Mortgage securitization agency Ginnie Mae is now on the opposite end of its cleanup process, researchers said. Ginnie prepayment speeds are likely to slow materially in Q110 as servicers work through Ginnie's pipeline of delinquent Federal Housing Administration-ensured mortgages. Investor confidence in ABS slipped in Europe as well, JP Morgan said in a recent European ABS Outlook: JP Morgan's European Confidence Index for ABS investors [pictured above] fell slightly in Q409 from the previous month but remains positive. It marks only the second consecutive period of positive feedback in the Index's three-year history. Projections for Q110 not only remain in higher positive territory but also expect improvement. UK RMBS performance looks to be stable in 2010. Write to Diana Golobay. The author holds no relevent investment positions.