JPMorgan Securities analysts looked at the shift in MBS sponsorship in a recent report. With mortgage OAS roughly five basis points wider than levels observed in April, the sector is now not so fundamentally rich that it would derail the participation of relative value investors such as hedge funds, money managers, etc. Greater participation by these investors would mean a shift from an environment where net purchases were almost dominated by banks and Asia. The consequence of this is twofold. The first is volatility could be bid somewhat higher as these investors have a greater propensity to hedge with volatility, and swap spreads could go wider as they hedge the duration. The impact of this activity could be seen in the widening of both swap spreads and mortgage spreads recently, analysts noted.

Longer-dated implied volatility has been a major driver of mortgage performance, as the sector has become increasingly efficient at reflecting volatility changes. Since the end of last year, the implied volatility on 3x7 swaptions - which are one of the structures most correlated to 30-year fixed-rate MBS valuations - has fallen by nearly a full basis point per day, before actually recently stabilizing. JPMorgan had argued that a further decline in volatility would lead to a narrowing in nominal spreads in mortgages. But, as the purchases of vega could offset the supply of vega from range accrual notes recently, the firm's derivative strategists are shifting to a neutral view on longer-dated volatility from being negative.

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