Yields on benchmark Fannie Mae securities dropped last week to 1.28 percentage points more than an average of 5- and 10-year Treasury rates, the narrowest since May 22, according to Bloomberg index data. The spreads, which advanced yesterday to 1.31, have fallen from a 15-month high of 1.51 reached in July, two months before the Fed surprised investors by maintaining its $40 billion of monthly purchases of housing debt.
Investors from TCW Group Inc. to Prologue Capital Inc. say it’s no time to bet against the $5.3 trillion market even as JPMorgan Chase & Co. and Barclays Plc analysts warn the securities are too expensive and the Treasury Department cautions that spreads could jump if Congress doesn’t act soon to expand the nation’s debt limit. Speculation is growing that the Fed will further extend bond purchases that represent about 70% of new issuance and have left it with $500 billion more of the debt than when a stalemate roiled markets in 2011.
“The messier it gets, the larger the markets believe the dose of medicine from the Fed will be,” said Bryan Whalen, co-head of mortgage bonds at Los Angeles-based TCW, which oversees about $130 billion. “We just saw their willingness to behave that way by not tapering.”
U.S. money managers that own about $860 billion of agency mortgage debt will need to see more evidence that the central bank is gearing up to scale back its purchases before they cut allocations to the market, according to Nomura Securities International analysts led by Ohmsatya Ravi.
While the investors hold $150 billion less than when the Fed started expanding its bond buying 13 months ago, they’re maintaining a so-called neutral position that’s consistent with the percentages found in benchmark bond indexes, the analysts said in an Oct. 4 report.
If the showdown between President Obama and Tea Party-backed Republicans escalates to the same degree as the 2011 fight that prompted Standard & Poor’s to strip the U.S. of its AAA rating, mortgage bonds would probably lag behind Treasuries in “a flight-to-quality rally,” said Noah Estrin, a portfolio manager at Greenwich, Conn.-based hedge fund Prologue Capital, which oversees about $2.3 billion. For now, the battle is now boosting their appeal, he said.
“The government shutdown and debt-ceiling debate is obviously going to keep the Fed a little more defensive,” Estrin said. “While I thought they were going to taper this year, I’m becoming more skeptical on that.”