3-day weekends are generally popular among the “weekday 9-5” crowd, but they can also bring elevated uncertainty to financial markets when the news cycle is volatile. With things still up in the air in terms of geopolitical risk, markets are seeking safer havens in general so far today. Most recently, this is affecting stocks a bit more than bonds.
This correlated movement is in line with conventional wisdom (i.e. buy bonds, sell stocks, or vice versa). But it’s often the exception. That’s especially true over longer time horizons and truer still when markets are adjusting to a shift in the Fed policy outlook. Bottom line, a less friendly Fed hurt both stocks and bonds in recent months. The correlation (driven by geopolitics) this past week is new.
How about the mortgage market though? It traditionally correlates almost flawlessly with Treasuries. We already know that covid threw that correlation out the window in 2020, but it had come back nicely by the middle of 2021. Even now, mortgage rates and Treasury yields are moving in the same direction, but definitely not at the same pace.
Viewed another way, here’s the relative performance of MBS versus Treasury yields of comparable maturities.
Here too, blame the Fed. The Fed’s recent policy shift hurts the mortgage market on 2 accounts. First, Fed bond buying constitutes a larger percentage of the total buying universe of newly originated MBS than it does newly minted Treasuries. As such, a reduction in overall bond buying is a bigger shock to MBS. Second, the Fed specifically stated it intends to hold only Treasuries in its securities portfolio. Even if that’s only an ‘eventual’ goal, it signifies another degree of MBS-specific unfriendliness on the part of the Fed.
There are non-Fed-related reasons for the underperformance as well, and they’re as simple as the nature of the most recent market motivation. Specifically, geopolitical unrest–when it moves markets–is always going to benefit the safest havens first. Treasuries will always be a bit safer than MBS. Note: “safety” in this context doesn’t refer to default risk. There really isn’t any default risk for agency-backed MBS these days due to the implicit government guarantee via the Fannie/Freddie conservatorship. The only risk is the uncertain timing of MBS “prepayment” (i.e. how fast a homeowner refinances or sells). Those prepayments have a surprisingly big impact on the value of MBS in the eyes of investors.
Lastly, MBS appreciate stability in the bond market. Volatility makes it harder for mortgage lenders to price and sell MBS efficiently. A stable valuation benchmark helps MBS spreads tighten and it helps lenders tighten their rate sheets to MBS. On this note, Treasuries are fighting to stabilize, but it remains to be seen if it’s just a geopolitically-motivated pause as opposed to organic support that brings reprieve after the recent rate spike. We’re watching key levels at 2.06 and 1.91 to get a better sense of this.