Fannie, Freddie mortgage bonds continue to outperform Treasurys

Investors continue moving to government-sponsored mortgage-backed securities, foreign private-label MBS and covered bonds, seeking yield in a low supply environment, according to analysts at The Royal Bank of Scotland (RBS). Analysts expect “the richness in the front end” of MBS backed by Fannie Mae and Freddie Mac to continue with the relative value in the five-year, agency sector. Agency spreads outperformed Treasurys and swaps this week on extremely weak demand and “sympathy with the low Treasury bill and discount note yields,” according to RBS. “This richness could continue as bill supply gets cuts into decreased Treasury funding needs, the Fed clearly on remains on hold per the minutes, and agency buyers scramble for paper into light issuance,” analysts said. Minutes from the latest Federal Open Market Committee meeting showed members of the central bank are ready to move away from expansionary monetary policies, but when remains unclear. RBS analysts expect about $62 billion of callable redemption in June, dominated by maturities of five years or less. That level of redemption would be the heaviest period of the past eight months. Callable redemptions total about $41 billion so far in May. “We recommend moving overweight mortgages and express our view in the Fannie 30-year 5% coupon,” said Barclays Capital securitization analyst Ajay Rajadhyaksha. “We see a number of factors that suggest a more favorable supply/demand dynamic for agency MBS.” Analysts also said Canadian covered bond spreads tightened this week “into a more investor friendly regulatory framework and profit taking has emerged.” Pending Canadian legislation would create a stronger market for covered bonds in the country and provide added security for investors, according to RBS. Write to Jason Philyaw.