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Battered Mortgage Sector May Be Set for a Performance Turnaround

Cheaper valuations on mortgage-backed securities might lead to an increase in demand.

(Bloomberg)—In terms of excess return versus Treasuries, the performance of mortgage securities since September provided fixed-income investors little to brag about over the holiday dinner table. All of this begs the question -- have mortgages cheapened enough for a turnaround?

This sub-par performance has seen the Fannie Mae 30-year current coupon option-adjusted spread widen to near two-year highs, currently at around 30 basis points, up from a paltry eight at the end of 2017. In addition, its current coupon yield over that of the 5-year/10-year Treasury blend now offers the largest pickup since April 25, 2017.

It is little surprise, then, that over the past two weeks that Bank of America Inc. and JPMorgan Chase & Co. have moved to an overweight position on mortgages, with both pointing to cheaper valuations as one of the catalysts for their decision.

The Bloomberg Barclays U.S. MBS index excess return versus Treasuries in October was -37 basis points, its 13th worst monthly performance over the past 120 months and its fifth worst over the last 60 months. November is shaping up to be another poor month as it currently stands at -17 basis points.

Walt Schmidt, who heads FTN Financial’s MBS strategist team, agrees with moving to an overweight position but cautions performance may be a bit bumpy through December as "the end of Fed purchases and now year-end liquidity logjams are casting a long shadow on the market." And, Schmidt points out, though mortgages have taken a beating since the beginning of October, on a relative basis “investment-grade corporates have done even worse."

According to JPMorgan, U.S. Treasury issuance is likely to surge higher next year while agency MBS net supply should decline. They look for mortgage OAS versus Treasuries to tighten 10 basis points in 2019.

To contact the reporter on this story: Christopher Maloney in New York at [email protected] To contact the editors responsible for this story: Christopher DeReza at [email protected] Dave Liedtka, Allan Lopez

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