Demand for floating-rate securities and protection from extension risk are top on the minds of investors who are uncertain about the full extent of future Fed rate hikes and the impact of the 45 basis points rise in the average monthly 30-year fixed mortgage rate since the beginning of May. We strongly advocate GNMA ARMs to such investors in the context of current pricing. In addition to recent price action, relatively low supply, and underlying borrower characteristics that make ARM mortgages less prone to extension risk than FRMs support value in ARMs.
Recent price performance of TBA GNMA ARMs has caused them to underperform Treasuries and swaps. During the course of the last month, while 2-year Treasuries have declined 1:02+ in price, low coupon TBA GNMA ARMs have declined by more than two points. This price decline has led to substantially wider OASs, which are 20-30 basis points wider than levels that prevailed a month ago. Importantly, OASs on GNMA ARMs are positive to the swap curve, signaling an attractive entry point into the sector.