Citigroup Global Markets analysts noted recently that 30-year 6.5s have recently underperformed and the dollar roll has dropped. Analysts said this might be caused by the threat of future origination as primary mortgage rates have moved higher over the past couple of months. However, analysts think that increased supply will lead to rising demand. Thus, they recommended taking advantage of recent weakness in 30-year 6.5s by adding exposure to this coupon.
Researchers stated that a considerable source of demand for 30-year 6.5s is those that are hedging mortgage servicing rights. This asset has a negative duration, which is similar to a mortgage IO strip, with the most relevant reference interest rate being the primary mortgage, analysts explained. The most effective way to add positive duration in the primary mortgage rate is to purchase the current-coupon secondary mortgage security or just the par priced MBS. With 30-year 6.0s at $99 and 30-year 6.5s just over $101, an almost equal combination of 30-year 6.0s and 6.5s accomplishes this. Realistically, there are other risks as well as constraints that will hinder MSRs from being hedged just with MBS, and a considerable amount of MSR duration is hedged by receiving fixed on swaps, analysts noted.