Market Outlook - BNP PARIBAS - Investment Services India

US: Poor Housing Underscores MBS Support
• Housing data in coming months should
continue to deteriorate as the purchase index
remains depressed. This underscores
continued government support for mortgages,
especially during the typically positive spring
seasonals. Spreads at the wider end of the
recent range and carry in higher coupons
should help mortgages outperform in the near
term.
• We continue to favour up in coupon,
particularly 6s as we approach prepayments.
Additionally, the 15Y sector looks rich vs 30Ys
and we like selling 15Y 5.5s vs 30Y 6s.
Mortgages have seemed to break their widening
fever seen since the beginning of the year. Money
manager interest at the wides this week particularly
helped. But the second leg in mortgage widening that
started around 12 January may have been aided by
the overall increase in risk premium as reflected in
corporate and ABX indices for example (Chart 1). It
is this backdrop of an overall increase in risk
premium that presents some risk for the mortgage
basis as the Fed exit looms. As mortgages richened
due to Fed purchases last year, investors likely sold
mortgages and moved to riskier asset classes.
Creation of excess reserves may have also helped
money make its way there. As Fed purchases end,
we could thus see an overall increase in the risk
premium. Money managers are likely to be the key
supporters of mortgages after the Fed exit given their
underweight positioning. As mortgages widened
considerably through the credit crisis, money
managers increased their allocation to agency MBS,
but were unable to shield them from an overall
increase in risk premia.
We had a considerably bearish outlook on mortgages
as a response to the MBSPP end (though positive in
the short term), and given that outlook we had placed
a high probability of the Fed extending the
purchases. The FOMC meeting this week continued
to leave the door open for that possibility. But given
the fails occurring in 5.5s, the largest coupon, it
would be difficult for the Fed to extend the purchase
programme without some retooling, perhaps buying
more GNs or moving into specified pools. There is
only a limited supply of higher coupons. As
discussed previously, there appear to be more than
enough bonds to deliver to the Fed, but that it’s
cheaper to fail than deliver is the likely underlying
Chart 1: Risky Assets Suffered since mid-Jan;
Mortgages May have Acted in Sympathy
100
95
90
85
80
75
70
12/28/09
12/31/09
Source: Bloomberg
1/3/10
1/6/10
Corp CDX 5Y Spd
ABX - 061- Px (rhs
- reverse)
1/9/10
1/12/10
1/15/10
1/18/10
1/21/10
1/24/10
1/27/10
Chart 2: Mortgage Current Coupon OAS vs the
5Y Agency (FN) Debt Spread
100
80
60
40
20
0
-20
-40
Curr Cpn LOAS - 5Y Agcy Debt Spd to Lib
-60
05 06 07 08 09 10
Source: BNP Paribas, Yield Book
Chart 3: Large Bank MBS portfolios vs FNCL 5
Px
$ bn
720
710
700
690
680
670
660
650
640
630
620
Jan-09
Feb-09
Mar-09
Source: Bloomberg
Apr-09
Large Bnk Holdings (lhs)
FNCL 5 Px (rhs, rev)
May-09
Jun-09
Jul-09
cause of fails. In the event a fail penalty is imposed
on mortgages, this problem may however diminish.
Aug-09
Sep-09
Oct-09
Nov-09
Dec-09
Jan-10
99
100
101
102
103
104
105
78
79
80
81
82
83
84
85
86
$ Px
Sergey Bondarchuk / Suvrat Prakash / Bulent Baygun / Anish Lohokare 29 January 2010
Market Mover, Non-Objective Research Section
31
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