Investors are rethinking their relative value framework for looking at the mortgage sector after Asian net purchases of mortgages have exceeded banks and agencies in all but one year since 2000, according to JPMorgan Securities analysts. While some investors are looking for "yield targets" where bank demand will resurface, others are exploring dollar/yen levels at which mortgages are more attractive to Asian buyers.
At the foundation of this currency-based approach is the notion that when the dollar is cheap versus the yen, Asian buyers should buy mortgages as they would benefit from the currency appreciation as well as the carry, and possibly even mortgage tightening as well. When analysts set out to explore this concept, however, the results were surprising.
"Ultimately, while looking at mortgage prices in yen terms has been popular with some market participants, there are fundamental issues with this approach (in addition to the lack of historical predictive power)," the firm's recent report said. Analysts stated that Asia, as a whole, has obviously played a significant role in the mortgage market even though many countries in the region have currencies that do not fluctuate versus the dollar. Although currency movements could impact Asian demand, other factors are equally important in driving these investors' preferences, analysts said.
In a comparison of the price of FNMA 5.5s (in dollars), as well as the dollar/yen exchange rate and the price of FNMA 5.5s (in yen, divided by 100), the price variability of FNMA 5.5s paled in comparison to the currency exchange moves.
That alone was not enough to prove that currency rates are not a useful indicator, however. The analysts also examined the regressions of the level of FNMA 5.5 OAS versus the price of FNMA 5.5s denominated in yen over various time periods. The results show that from 2004 to the present - at a time when one would think that the relationship was the strongest based on strong Asian net purchases and shrinking agencies' portfolios - there was practically no relationship.
Using a six-month window, JPMorgan analysts also looked at a rolling regression of weekly changes in OAS, versus changes in the price of FNMA 5.5s in yen. The average correlation was close to zero, and it flipped a sign a number of times, which, according to the analysts, is not a strong predictive indicator.
"In the end, we believe that Asian demand will be driven by a number of macroeconomic factors, including U.S. trade deficit and the need for investors in the region to reinvest in dollars," the report concluded. "Many of the investors in that region are banks, and we believe the best approach to gauge their sponsorship is to examine tradeoffs between potential price appreciation and yield."
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