Recent weakness in the agency mortgage-backed securitization market may be a product of the growing view point that unwarranted housing strength will force the Federal Reserve to exit the open-ended third round of quantitative easing sooner than expected.
Ultimately, this is not a good scenario for investors in securitized products, said MBS strategists Chris Flanagan and Matthew Carr at Bank of America Merrill Lynch (BAC) in a report.
“We suspect that the market will anticipate well ahead of the Fed that it cannot continue QE3 for an indefinite period in the face of such strong home price growth and that it will end the purchases well ahead of the market’s current consensus of early 2014,” the analysts stated.
CoreLogic’s (CLGX) recent report noted that year-over-year home price growth for December rose to 8.3%, raising the risk that home price progression will move even higher in 2013 due to momentum effects, BofAML noted.
Click on the chart to view year-over-year home price growth.
BofAML analysts noted the timing of the big moves in in year-over-year price growth coincides with QE1 starting in early 2009 and currently continues through QE3.
“We think it is safe to say that QE has been enormously successful in turning home price growth around from historically negative levels in early 2009 to levels that are now approaching those of the early 2000s bubble. While the Fed professes to be focused primarily on the unemployment rate, we think there is a good chance that the catastrophic consequences of its past disregard for home price growth may give it some pause in doing so this time arothiund,” Flanagan and Carr said.
Since the release of the December Federal Open Market Committee minutes, the MBS market has reached a turning point, recognizing that QE will finally wind down.
Although QE3 currently remains in effect and is expected to do so throughout 2013, the program is no longer pushing securitized products’ asset prices ‘monotonically higher,’ the analysts stated.
Thus highlighting the underperformance of agency MBS due to the risk of a disorderly selloff in the rates market, the report noted.
“Investors may well be recognizing that exiting their MBS holdings anywhere near the actual end of QE3 might prove to be exceptionally challenging. We may well be seeing MBS investors getting way ahead of that problem,” according to the analysts.
On a separate note, nonagency MBS prices have trended slightly lower over the past few weeks, indicating that selling as well as profit taking will continue, giving investors better entry points into the market.
“While we remain constructive on the sector, we caution investors to thoroughly analyze collateral pools before making investment decisions, as there is little room for error at current levels,” said MBS strategists Ryan Asto and Justin Borst at BofAML.
Recently, the Mortgage Bankers Association announced its refinancing index grew 4%, as concerns mount on the possible three-year nonagency MBS rally reaching the beginning of the end.
Thus, President and Co-Founder James Frischling at NewOak Capital questions where investors should go for returns with major bond fund managers calling for an end to the bull-run in bonds.
“With bond gurus warning of an inevitable increase in interest rates and hit to bonds and with equity markets trading at historically high levels, investors with capital to deploy are searching for returns,” he added. “The environment suggests the risk-on trade is still very much in effect, but the liquid markets represent a scary place to deploy capital given their performance over the past few years.”
