Market Update: Follow up on last weeks Prepay Update letter

I thought this afternoon would be a good time to provide a follow up on last weeks Market Update titled “Very Important Update on MBS prepays” that discussed rumors of a new effort to generate refi activity.  The e-mail discussed selling higher coupon MBS to lock in gains and/or avoid an increase in prepays that would erode gains and burn down yield. 

The idea was to first decide if you thought this was a realistic risk factor.  If you didn’t view it as a risk then there would be nothing to do. 

For those that viewed the risk as material we discussed quickly identifying bonds that you wanted to sell and to do so before the market reacted and began pricing this risk in.  The idea was that prices on higher coupon MBS would drop, and prices on the lower coupon MBS would rise (and put further downward pressure on reinvestment yields).

This afternoon the market began pricing in this risk.  MBS with maturities of 15 years or longer and coupons higher than 5.00% are trading lower today despite a big rally in the Treasury market.  The 10-year Treasury is up 21/32’s right now to offer a 2.68% yield while MBS prices on the aforementioned coupons are down anywhere from 4/32’s to 7/32’s this afternoon.  At the same time, prices on the lower coupon MBS are trading higher.  This is exactly what we warned of in last week’s e-mail.  Many investors have already made their decisions and have taken appropriate action. 

For those that are still on the fence it might be helpful to note that bids are starting to fade and prices are rising on reinvestment options.

As we said from the outset, each investor will have to make their own decision as to whether or not this risk factor has a high enough probability to compel one to act.  If you don’t view this as a material risk factor then you can move on to more productive things.  If you fall into the camp that is concerned about this issue then you should note that your timeline for action just got shorter.  The market is beginning to move against this trade.

If you have any questions or if there is anything we can be doing for you just let me know.

Steve Scaramastro, SVP

800-311-0707