U.S. Treasury buysiders may be looking to the MBS market as interest rates continue to rise, researchers at Bear Stearns stated in a report today. Analysts noted blocks of passthroughs currently trading below par for the first time in over a year, and this type of pricing has removed the underlying mortgages from the refinancing radar. Bear said that structured MBS backed by these cash flows appear to be manageable alternatives to Treasurys. They suggested a couple of trades: three-year or shorter PACs vs. Treasurys and five-year PACs vs. Treasurys.

Bear noted that in the last two weeks almost $97 billion in 30-year passthroughs, specifically 5s, have lost their simplest refinancing incentive. Meanwhile, another $516 billion in 30-year 5.5s is on the brink of sinking below par. With 30-year mortgage rates now over 6.20%, the borrowers behind these loans have seen cash out and cheaper monthly payment incentives disappear.

The firm added that the reappearance of a market in discount passthroughs does change the number of opportunities in mortgages. In June, when 96% of outstanding mortgages had good refinancing incentives, buysiders that wanted to be in MBS could only do it by taking on the risk of fast-moving cash flows. This might have driven away portfolio managers even slightly wary of managing prepayment risk. Discount passthroughs provide a more manageable entry point for those portfolios. Bear added that PACs tailor the risk even further.

Total return managers should strongly consider selling Treasurys to buy PACs backed by discount passthroughs, Bear analysts said. The timing is right as the potential returns look attractive, and the cashflows are much more stable than only a month ago, they added.

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