With Ginnie Maes looking rich to conventionals overall, investors should underweight the sector, said analysts from Deutsche Bank in a recent report.
However, the underweight recommendation somewhat clashes with the firm's concern about higher volatility and/or swap spreads; however, analysts said that implied volatility and swap spreads are negatively correlated at these rate levels. This is particularly the case as rates increase (by about more than 50 basis points); swap spreads will likely widen as mortgage hedgers start lengthening the duration of their hedges. At the same time, an increase in rates will most likely be accompanied by a more apparent economic recovery as well as a corresponding decrease in uncertainty and volatility.
Deutsche analysts said that if investors believe that it is unlikely that volatility and swap spreads increase in tandem, then there is really no value in a Ginnie Mae neutral or overweight position, considering the degree of difference in OASs. Furthermore, they stated that the only feasible way to currently be neutral or overweight in the sector is to believe that volatility will increase while swap spreads widen.
GNMAs saw a considerable increase in interest with the corporate accounting scandals and the resulting dip in stocks, as investors fled to Treasury funds. Analysts believe that this move is currently rather limited. This is considering the 50 basis point rate cut by the Fed, improving corporate profits - as well as signs of an improving economic picture.
Analysts said that high prepayments are the only positive factor for Ginnie Maes. However, with rising mortgage rates, this positive will likely not be lasting long. Furthermore, while prepayments have been high, they have not been much faster than most predictions.
Ginnie supply dips
Meanwhile, JPMorgan analysts in a recent report said that Ginnie Maes are on pace to dip by $60 billion in 2002. Furthermore, it may decline by another $20 billion to $30 billion next year.
Ginnie Mae funds, on the other hand, have added over $30 billion in assets this year. Though this pattern should slow next year, net inflows are expected to remain positive. Aside from this, off-shore banks have been net buyers of Ginnies at about the same level. Researchers said that this supply/demand imbalance should continue to support the Ginnie Mae market.
The sector might benefit as well from improved convexity for new Ginnie Maes next year, as the Agency recently announced that buyout activity is limited to pools issued post January 2003. Analysts said that it would not surprise them if GNMA/FNMA swaps end 2003 at stronger levels. They suggested an overweight to Ginnie Mae 6s and Ginnie Mae II 5.5s for January.