In research released last week, UBS recommended investors move up in coupon. Higher coupons have lagged recently on originator supply that has been focused in 5.5% and 6% coupons and servicer selling in higher coupons to buy 5s and 5.5s. Furthermore, analysts from UBS prefer coupon swaps versus IOs as coupon swaps are currently cheaper than IOs.
Their analysis shows that 6.5s are the cheapest on the stack. For example, their model calculates FNMA 6.5s are 9.31 ticks cheap to 5.5s. Analysts added that carry from being long 6.5s and short a hedge-adjusted 49.7% 5.5s is currently 1.75 ticks. The carry as well as the level of cheapness means "that if the 6.5/5.5 swap reverts to fair value in one month, the 6.5s deliver 11.07 ticks more over the month than do the 5.5s," analysts said. Additionally, UBS stated that the 6.5/5.5 coupon swap is 23 ticks cheap to 6% IO (FNS 361).
Another benefit the analysts' noted was that the negative convexity in higher coupons has been reduced as the market has moved out of a refinancing environment to a purchase environment.
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