While the technical backdrop has improved for mortgage-backed securities, the vast majority of investors appear complacent with respect to the Federal Reserve’s exit from the market, said JPMorgan Chase in its latest survey.
About 75% of investors expect the central bank to begin tapering their asset purchases after 2013. In addition, investors expect any tapering to begin with Treasuries since mortgage-backed securities continue fueling the housing market, analysts at JPMorgan (JPM) noted.
Similarly, analysts for Barclays (BCS) expect MBS purchases to continue well into 2014, with Treasury purchases ending this year.
The end of the first-round of quantitative easing is the best template for what is likely to happen to mortgage spreads in a post-third round of quantitative easing world, Barclays noted.
"Mortgage spreads widened out steadily at the end of the purchase program with some spread widening attributable to paydowns from Fed portfolio hitting the market and some attributable to European driven spread widening in most spread products," analysts for Barclays explained.
Additionally, new sources of demand will emerge as supply dwindles into higher rates.
"Overall origination volumes are likely to drop as rates sell off, while real estate investment trusts should lead on the demand front, followed by banks," analysts of Barclays explained.
However, while Barclays and bond investors seem to believe tapering will not unfold until some time next year, JPMorgan economists expect tapering of purchases to begin at the December Federal Open Market Committee meeting.
"Investors could be unpleasantly surprised by more hawkish Fed commentary, and mortgage performance may be more data-dependent than usual as a result," the report explained.
Meanwhile, the reason for lackluster performance of MBS is due to the Fed’s massive purchase program under QE3, which has been met by equally massive selling by investors, resulting in a temporary stalemate in spreads, JPMorgan analysts explained.
As a result, JPMorgan remains neutral on the mortgage basis and looks for the technical backdrop for private investors to stabilize before turning positive again, depending on spread level.