MBS Day Ahead: Bond market in the midst of repricing, but not the kind you are used to
Our typical definition of “revaluation” has to do with re-pricing by mortgage lenders, but the term has always existed beyond our small area of the market. There are times when the general pricing environment for certain assets is stable and there are times when something happens forces a rethink this price environment. In this case, it is a rethinking of the yield curve for government bonds based on Wednesday’s updated dot chart. In short, longer maturity Treasuries do very well and shorter maturities Treasuries go up. MBS will underperform the 10-year benchmark in this environment (although they outperform 5-year government bonds). Comments from Feds Bullard do not help.
For those who see the word “Benchmark“and wonder what that means. Just think of it as a yardstick by which to measure other assets. In the bond market, Treasuries are the most basic and widely used benchmarks for USD-denominated debt because they (practically) the risk-free debt the US government.
We have some leeway in choosing which benchmark to use, and we should try to pick one that has a duration similar to MBS. Since MBS moving targets (ie they can last longer or shorter depending on the price development), no single benchmark is always perfect. In view of the reassessment of the yield curve, the representation of MBS compared to several benchmarks gives several very different impressions. The first chart is the spread between MBS returns and the good old 10 year return.
In the graph above, MBS are weakening quickly compared to Treasuries. But what if we use the 5yr as a benchmark instead?
In the graph above (versus 5 years), MBS are back in line with some of their best relative levels. Finally, we can opt for a warm bowl of porridge benchmark and use the 5/10 year mixed yield.
This accurately captures the recent expansion / underperformance trend at MBS without making it look like it quite so dramatic as the first chart (compared to just 10 year returns). What does this mean for the strategy or the outlook? Not much at the moment. I wouldn’t argue that MBS are building buy demand reserve just because spreads are higher than they were in April and May. Spreads have been too tight and significantly too tight during these months with Bullard and other Fed spokespersons talking about unequal treatment of MBS when the time runs out.
The bigger news, or rather, the one more relevant Development for bonds in general would be the transformation of the broader trend from a sideways pause into a linear trend towards slightly lower yields. This gives us some limits to work with in terms of playing the range (i.e. looking for opportunities to be defensive when returns are rising on the lower yellow line and optimistic when returns are rising on the upper line) .
MBS pricing overview
The price shown below is delayed, please refer to the timestamp below. Real-time prices is available through MBS Live.
|Prices from 06/18/21 11:04 a.m.|