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Public Fixed Income

Mortgage-Backed Securities: A Timely Opportunity

November 2023 – 3 min read

Uncertainty over the direction of interest rates has led to a significant widening of spreads in the agency mortgage-backed securities market, creating a potentially attractive opportunity for investors.

Powerful but oscillating technical forces have driven the mortgage-backed securities market in recent years. First, in the wake of the pandemic in 2020 and 2021, the U.S. Federal Reserve (Fed) and banks added roughly $2 trillion in mortgage-backed securities (MBS), crowding out other investors. In 2022, as the Fed reversed course and began raising rates to douse escalating inflation, relative value buyers began to dominate demand. Today, with the Fed taking a steadier course, and with MBS spreads and yields at or near their most attractive levels in more than a decade, we believe valuations are at a level that create a timely opportunity.

Where the Market is Now

The Fed’s 18-month hiking cycle and uncertainty around the effects of that policy on economic growth and inflation have led to a sustained period of interest-rate volatility. This has significantly widened agency MBS spreads versus U.S. Treasuries and corporates, presenting an attractive opportunity for investors to increase agency MBS weightings in core asset allocations. Currently, agency MBS represents about 20% of the U.S. fixed income market, second only to U.S. Treasuries in size and liquidity; it also represents about 25% of the Bloomberg Barclays Aggregate Index.

MBS spreads1 versus Treasuries have been trading between 160 and 190 basis points (bps), versus a 10-year average spread of 103 bps, levels that are exceedingly unusual (in the 99th percentile)2. Option-adjusted spreads (OAS), which account for the embedded options in which investors are short, currently are at about 65 bps, versus a 10-year average of 14 bps, putting that measure in the 99th percentile. Valuations rarely have been this wide, and we have only seen these levels twice since the global financial crisis—when pandemic shutdowns began, and during the spate of regional bank failures in early 2023.

1. Source: Current coupon MBS is derived from MBS coupons that trade above and below par. Current coupon 30Y MBS spread is quoted vs. a blended 5 and 10-year U.S. Treasury rate.
2. Source: As of October 31, 2023.

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Alan Alegado, CFA

Senior Director, Securitized Trading

The document is for informational purposes only and is not an offer or solicitation for the purchase or sale of any financial instrument or service. The material herein was prepared without any consideration of the investment objectives, financial situation or particular needs of anyone who may receive it. This document is not, and must not be treated as, investment advice, investment recommendations, or investment research.

In making an investment decision, prospective investors must rely on their own examination of the merits and risks involved and before making any investment decision, it is recommended that prospective investors seek independent investment, legal, tax, accounting or other professional advice as appropriate.

Unless otherwise mentioned, the views contained in this document are those of Barings. These views are made in good faith in relation to the facts known at the time of preparation and are subject to change without notice. Parts of this document may be based on information received from sources we believe to be reliable. Although every effort is taken to ensure that the information contained in this document is accurate, Barings makes no representation or warranty, express or implied, regarding the accuracy, completeness or adequacy of the information.

Any forecasts in this document are based upon Barings opinion of the market at the date of preparation and are subject to change without notice, dependent upon many factors. Any prediction, projection or forecast is not necessarily indicative of the future or likely performance. Any investment results, portfolio compositions and/or examples set forth in this document are provided for illustrative purposes only and are not indicative of any future investment results, future portfolio composition or investments. The composition, size of, and risks associated with an investment may differ substantially from any examples set forth in this document. No representation is made that an investment will be profitable or will not incur losses. Where appropriate, changes in the currency exchange rates may affect the value of investments.

Investment involves risks. Past performance is not a guide to future performance. Investors should not only base on this document alone to make investment decision.

This document is issued by Baring Asset Management (Asia) Limited. It has not been reviewed by the Securities and Futures Commission of Hong Kong.

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