Agency mortgage-backed securities (MBS) have rallied in recent weeks. The catalyst was President Trump’s announcement of a $200 billion mortgage bond purchase program to lower mortgage rates and support housing affordability. As a result, agency MBS spreads have tightened, leading some investors to question whether the appeal of MBS has diminished. Although the recent rally has moderated the sector’s valuation advantage from last year, current fundamentals still support an overweight allocation.
Relative value remains a key factor. Demand for yield in recent years has compressed risk premiums across fixed income, leaving investors poorly compensated for taking higher credit risk. The yield premium between high-yield bonds and MBS has collapsed from ~9.0% in 2020 to just ~2.4% today, while investment-grade corporate spreads over Treasuries have tightened to their lowest levels since the GFC. In contrast, MBS spreads remain above 2021 lows, leaving room for further tightening. With AI-capex financing needs boosting issuance in the IG market and the growing risk of fallen angels (companies downgraded from IG to junk status due to excessive debt), the risk-reward for IG corporate spreads is skewed toward wider spreads. According to a Goldman Sachs report, MBS have historically outperformed when IG spreads widen by at least 5bp.
Structural and housing-market conditions are also supportive. Agency MBS offer government-backed repayment and are of higher credit quality compared to high-yield and IG corporate bonds. While refinancing activity has recovered from its 2023 lows, it remains well below average levels seen over the past two decades. At the same time, existing home sales remain subdued, as many homeowners who locked in mortgage rates below 4% before 2022 continue to refrain from refinancing, despite mortgage rates recently easing to around 6.2%. This has helped prevent sudden increases in new mortgage supply and provides a stable backdrop for MBS cash flows.
In conclusion, with recent policy support strengthening demand, spreads at relatively compelling levels, and structural risks contained, MBS remain well positioned within fixed income allocations. They offer attractive income, higher credit quality, and defensive characteristics at a time when corporate spreads are at historically tight levels.
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This material represents an assessment of the market and economic environment at a specific point in time. It is not intended to be a forecast of future events or a guarantee of future results.
Debt securities are subject to interest rate risk, credit risk, extension risk, income risk, issuer risk and market risk. The value of U.S. Government securities can decrease due to changes in interest rates or changes to the financial condition or credit rating of the U.S. Government. Investments in asset-backed and mortgage-backed securities are also subject to prepayment risk as well as increased susceptibility to adverse economic developments. High-yield, lower-rated, securities involve greater risk than higher-rated securities. Loans are subject to risks involving the enforceability of security interests and loan transactions, inadequate collateral, liabilities relating to collateral securing obligations, and the liquidity of the loans. Equity securities generally have greater price volatility than fixed-income securities and are subject to issuer risk and market risk.
