In its 2009 MBS outlook, JPMorgan Securities analysts recommended an overweight to MBS versus Treasurys heading into the new year.
They base their suggestion partly on their supply/demand outlook for the MBS sector, surging Treasury issuance and the prospect for narrower swap spreads in the front end.
Analysts currently project net supply to total $490 billion compared with an estimated $530 billion for 2008. Ginnie Mae is expected to represent 51% of the total, Fannie Mae 31%, and Freddie Mac just 18%. Overall, JPMorgan predicts the agencies to represent around 90% of issuance as the private label market remains largely shut down. In fact, they don"t expect new securitizations in this sector until the second half of 2009.
Net supply could ramp up towards $700 billion if mortgage rates average between 5.25% and 5.5%, analysts said. This could be achieved through a reduction in agency g-fees, tightening in the mortgage basis, or policies that would provide streamlined agency refinancing like the Federal Housing Administration's program.
Sponsorship from banks, overseas, money managers, the government, and the GSEs look to be able to more than absorb the $490 billion supply outlook plus an additional $80 billion from dealers and hedge fund deleveraging. Analysts point out that while banks will continue to have to deploy capital conservatively, they are under increased pressure to put the capital to work to help the economy. In favor of MBS is the recent cut in the risk-based capital weightings for agency securities and good liquidity. Analysts estimate banks could grow their MBS portfolios by $100-$150 billion.
Overseas support is anticipated to be lower as the narrowing trade deficit requires overseas institutions to reinvest less back into the U.S. fixed-income market. In addition, overseas governments are involved in stimulating their own growth. Still, they expect foreign sponsorship to amount to $75 billion for the year.
Money managers are also likely to be less supportive of the sector in 2009, but J.P. Morgan looks for $50 billion in mutual fund and pension fund purchases over the next year.
These three groups banks, overseas and money managers are expected to take up around 40% to 48% of the total supply ($490 + $80 billion), leaving the rest to be absorbed the GSEs, Treasury and Federal Reserve. Programs that are in place or soon to be appear to offset by a respectable margin the remaining supply.
The GSEs have room for $180 billion based on their current portfolio sizes. Analysts acknowledge that key to growing their portfolios is a resolution in their ability to issue debt. But "despite narrow MBS valuations versus their debt they are likely to still grow their portfolios up to the maximum allowed under conservatorship."
Treasury is predicted to hold to similar levels seen in October of $21.5 billion.
In related news, the Fed last week announced its intention to buy MBS backed by FNMA, FHLMC and GNMA. In its press release, the Fed said purchases of up to $500 billion in MBS would be conducted by selected asset managers "with a goal of beginning these purchases before yearend" and is expected to continue over several quarters.