The activity in MBS (Mortgage Backed Securities) markets - and other financial markets - has been very unusual this month. The Fannie Mae Required Net Yield has already made two round trips from about 5.70% to 6.60% over the past few weeks, displaying a level of volatility rarely seen. Under normal market conditions, the vast majority of the significant rate movements are the result of fresh economic news. This month, however, it has been common to see large rate movements unconnected to any news announcements, for reasons I'll discuss below.
One reason is that the credit crisis has forced many investment funds and financial institutions to reduce their leverage and raise capital. In many cases, these big holders of MBS are selling assets across their portfolios. This explains why MBS, stock, oil, and other markets have frequently all been falling on the same days. The fundamental economic data clearly supports lower mortgage rates. Global economies are slowing, oil prices are down, and expectations for future inflation are moving lower. As long as these investment funds are forced to sell assets, however, there will continue to be upward pressure on mortgage rates. How long it will last is one of the biggest questions facing investors today.
A second factor is that many investors are seeking to reduce the level of risk in their portfolios. They are buying Treasuries, mostly shorter-term, which are considered the safest and most liquid investment. These investors are generally not turning to MBS, and MBS prices have performed worse than Treasuries this month, meaning that the spread between mortgage rates and Treasury rates grew wider. Agency MBS might appear to be a safe alternative to Treasuries. Investors seem to be fairly comfortable with the guarantee that the US government backs Fannie Mae and Freddie Mac MBS, as they are now trading very close in price to Ginnie Mae MBS. One fundamental concern remains, however. The question is not whether investors will get their money back, but rather when they will get it back. MBS yield more than comparable Treasuries because MBS have prepayment risk and Treasuries do not. The recent volatility and uncertainty in financial markets makes it more difficult to evaluate the prepayment risk, so investors are demanding higher yields.
I just thought you might like some extra explanation. If you have any other questions, feel free to call or e-mail me
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