As mortgage spreads gapped out last Tuesday to 129 basis points over the 10-year Treasury - approximately equivalent to a full double-A corporate spread - issues of political risk in the mortgage-backed securities market, volatile swap spreads and the spectre of illiquidity are making some market participants wonder whether a new world order has emerged for MBS.
"The market has adopted a new trading paradigm wherein this fear of GSE reform causes swaps to widen, which causes mortgages to widen, and then causes Ginnie Maes to outperform," said an MBS expert. "When people seem more comfortable with it, however, the opposite happens. So it is really a three-part phenomenon: swaps, conventionals and Ginnies are all going their separate ways."
Whereas in the past Ginnie Mae securities were closely coupled with conventionals and swaps, they've become "delinked" of late, sources say, and have become more of a mortgage "flight-to-quality" trade.
"That is kind of different than what we've seen in the past," the source said.
As investors become more comfortable that Rep. Baker and Undersecretary Gensler's slated GSE reform will not happen this year - and is perhaps more harmless than expected - people who were buying Ginnies for their full faith and credit seem to be giving some of that up activity.
"Some overseas accounts were bulk-buying Ginnies, and other people were trying to front-run and piggy back on that," said an MBS trader. "Overseas accounts are still inclined to buy Ginnies, whereas others will trade according to how they perceive the political issues are being addressed."
While most market players do not think that GSE reform will happen this year, it seems almost a certainty that it will be an important factor for investors for the rest of the year.
"It remains a contentious issue through the November election, and if Congress is constituted as it is now, it will remain an issue throughout the entire next congressional term," said Michael Youngblood, managing director of real estate at Banc of America Securities. "Baker indicated it would take another two years to achieve objectives in limiting GSE leverage. Clearly, the personal attacks on Baker and Gensler were ill advised.
"But with all these uncertainties, it will be hard for agency debt to the spreads that we had on January 16, which were our narrowest of the year...which is a frightening thought."
However, other researchers were of the opinion that political risk might not be as important a factor as many people feared. "There is a new administration coming to town with a new Congress," said Art Frank, head of MBS research at Nomura Securities. "It is unlikely that the GSE regulatory changes are going to be at the top of the priority list. Political risk has been exaggerated. And spread is volatile; when it approaches a double-A corporate spread, there are buyers. I think 129 over Treasurys is temporary insanity, but it did not last very long."
Still, the issue of GSE reform has caused sparks in the bond markets and is generally being considered as a long-term phenomenon that will certainly come to the fore within the next year or two. Though there is no resolution in sight now, many factors depend on the outcome of the issue - especially the notion that the benchmark for the mortgage markets might change.
"On the one hand, people want to create a benchmark out of Fannie Mae, but on the other hand, people still can't define the exact relationship between these agencies and the U.S. Treasury," said the MBS trader. "That is not tenable in the long-term."
On the Week
Still, market players saw a general improvement in all spread product towards the end of last week that has not yet led to a change in relative value between the spread sectors.
For the most part, sources say there were active two-way flows and a restoration of normal trading volume, whereas the week before, there were only one or two normal days of trading.
Additionally, towards the week's end, mortgages saw steady flows continuing, though more modest buying than in the past two sessions. More investors seemed to be hopping on the bandwagon, with insurance and overseas investors becoming more active.
Near close last Thursday, 30s were outperforming by 3.6 ticks with conventionals up 4.5 ticks vs. 2.7 ticks in GNMAs. Spreads were mixed on the day, with 30-year 6s through 7s two basis points tighter in both sectors. Additionally, better interest was seen in 6s through 7s and in the conventional sector.