Researchers at some firms were recommending overweighting agency MBS Wednesday morning, saying relative yield advantages and the likelihood of continued tight underwriting could outweigh negative convexity concerns as more market turbulence continued to drive rates lower.
The long-term rate-indicative 10-year yield continued to fall and was near 2.1% as of late morning and the Dow was down more than 300 points shortly after noon.
Chris Flanagan, head of US mortgages and other structured finance research at Bank of America Merrill Lynch, told this publication that while investors need to address prepayment risk, the yield advantage of agency MBS over Treasurys argues for an overweight of the GSE MBS.
This yield advantage “is spiking to incredible levels by any historical measure,” he said.
“You have to hedge and be somewhat concerned about higher prepayments, I would not say that it is absolutely nothing, and you have to be careful about exactly what sector you are in,” he said. High credit quality product in the 15-year sector, for example, should be approached with caution as it is more likely to face refinancing pressures “but overall the whole mortgage universe is going to be pretty tight.”
Although applications have picked up, Flanagan said he considers the increase in apps is ”still fairly modest by any historical measure."
“Even if people apply it doesn't mean they are going to get through," he added.
Barclays Capital researchers in a report Wednesday morning also said they believe the time is right to overweight the mortgage basis and argued for the yield advantage of spread product such as agency MBS over Treasuries