With lower benchmark rates and little option-adjusted-spread, U.S. mortgage-backed securities are currently offering negligible upside, but plenty of risk. The main institution keeping prices high is the U.S. Federal Reserve. The Fed seems to have an endless balance sheet, which is now 33% of GDP, up from about 6% before the global financial crisis.
Falling yields: Rates on 30-year mortgages have plunged to generational lows, but the critical residential MBS sector has seen yields fall even further. They currently are only a little more than 1% and have fallen almost 450 basis points from the end of 2006.
Jingle mail, take 2? Home loan delinquencies were at all-time lows in 2019, but have risen dramatically and are approaching 10% now. Fannie Mae and Freddie Mac are planning to add a new special fee onto mortgage refinancings starting Dec. 1 because of "risk management and loss forecasting."
Chugging along: One positive development for MBS: housing prices, which have increased year-to-date. This has been driven partially by increases in affordability from falling interest rates. However, the 35% decline in housing prices during the GFC should not be forgotten.
Hold your nose: With increasing fundamental risk and negative real rates, who would buy (has to buy) MBS? Oh yeah, the U.S. Federal Reserve (and passive investors).
*Bloomberg Barclays US MBS Index Total Return Value Unhedged USD. Source: Bloomberg LP
