In a recent report, JPMorgan Securities analysts suggested that investors move up to 6.5s. They noted that the mortgage spread tightening has really not been equally distributed across the coupon stack, adding that lower coupons have been the star performers. This is because selling, specifically from servicers, has actually pressured higher coupons in the rally. In the past month, 30-year 5s have tightened by six basis points, which meant they actually outperformed 6.5s by seven basis points. The firm's recommendation to own the condor (5s and 6.5s versus 5.5s and 6s) underperformed over the previous week, this is while the middle of the stack outperformed. At this juncture, 6.5s are becoming fairly attractive on an outright basis, analysts stated.
With prepays decreasing slightly more than the firm's expectations, and with the exception of Trust 371 (off new 6.5s), 6.5 speeds were benign, dipping 17% relative to the June print. At an assumed long-term speed of 15 to 20 CPR, they offer a Libor static spread of 60 to 70 basis points, said analysts. Carrying an option cost of about 70 basis points, the coupon now provides a Libor OAS of zero, which is the biggest in the stack. By contrast, conventional 5s through 6s are in the -8 to -10 basis point range. Analysts recognize that TBA investors could receive pools with idiosyncratic speeds in the short term. However, analysts think that at conservative long-term speeds, the spreads are actually compelling, and that as issuance picks up ($8.2 billion in July), the TBA characteristics will improve. Furthermore, hedge-adjusted carry in 6.5s is a half to one tick pickup relative to 5s and 5.5s, analysts from JPMorgan stated.
UBS analysts also like 6.5% coupons observing that it is the cheapest coupon on the stack currently. In addition, they believe the coupon has scarcity value. The researchers calculate available production at $10.2 billion FNMAs and $4.3 billion Golds; however, after consideration for paydowns, net available production is $3.0 FNMAs and less than $1 billion Golds. Given that 6.5s make up a small part of the coupon stack, and available production is growing slowly, they believe the coupon is vulnerable to a squeeze.
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