Agency MBS: A Yield Opportunity Amid Market Turbulence

Agency mortgage-backed securities, often called agency MBS, are bonds backed by U.S. mortgage loans. They come with a guarantee from major U.S. agencies like Fannie Mae, Freddie Mac, or Ginnie Mae.

Historically, these securities have been highly liquid. They’ve also provided better returns than Treasury bonds across the entire economic cycle. This stability is a key reason for their appeal.

Currently,agency mortgage bonds offer attractive relative spreads compared to investment-grade credit bonds. Normally, agency MBS have lower spreads over Treasuries than corporate bonds because corporate debt carries more credit risk.

The widening of agency mortgage spreads today is primarily due to excess supply in the market. this surge in supply stems from two main sources.

Firstly, the Federal Reserve’s quantitative tightening (QT) is allowing its balance sheet to shrink. This process adds an estimated $15 to $20 billion in extra bond supply each month. The second factor is reduced purchasing by the U.S. banking sector.

Banks bought fewer mortgages during 2022 and 2023 as their deposits declined. With these two major buyers absent, spreads have widened without natural buyers to absorb the increased supply.

looking ahead, the Fed is unlikely to return as a buyer of agency mortgages. Though, as the Fed continues to shrink its balance sheet, the negative impact of QT will diminish over time.

while bank purchases remain below ancient trends, we anticipate they will become a net positive again in 2025. This suggests spreads on agency MBS shoudl normalize. Simultaneously occurring, the current high yields and wide spreads present an attractive prospect.

These elevated yields offer a solid return while we await spread normalization. Our firm has considerably invested in agency mortgages, both in dedicated funds and across our diversified fixed-income portfolios.

This strategy has allowed us to enhance both the credit quality and yield of our portfolios. It also makes them more defensive, all without compromising on returns.

this facts is for educational purposes only and should not be considered financial advice. Investing involves risk, and it’s essential to consult with a qualified financial advisor before making any investment decisions.

What strategies can investors employ to mitigate prepayment risk in Agency MBS during periods of interest rate volatility?

Agency MBS: A Yield Possibility Amid Market Turbulence

Understanding Agency Mortgage-Backed Securities (MBS)

Agency MBS represent a significant portion of the fixed-income market, offering investors a pathway to participate in the housing finance sector. These securities are backed by mortgages guaranteed by government-sponsored enterprises (GSEs) like Fannie Mae, Freddie Mac, and Ginnie Mae. This government backing is a crucial element,providing a level of credit risk protection not typically found in other mortgage-backed securities. Understanding mortgage-backed security yields is key to navigating current market conditions.

What Makes Agency MBS Different?

Government Guarantee: The primary differentiator.GSE guarantees mitigate credit risk,making them generally safer than non-agency MBS.

Pass-Through Structure: Payments from underlying mortgages (principal and interest) are “passed through” to investors, less servicing and guarantee fees.

Prepayment Risk: A core characteristic. Homeowners can refinance or sell their homes, leading to faster-than-expected principal repayment. This is a major consideration when evaluating MBS investments.

Liquidity: Agency MBS are generally highly liquid, especially those issued by Ginnie Mae and Fannie Mae, facilitating easier trading.

Current Market Dynamics & Yield Opportunities (July 13, 2025)

Market turbulence, driven by factors like inflation, interest rate volatility, and economic uncertainty, has created a compelling yield opportunity in Agency MBS. While broader fixed-income markets have experienced significant swings, Agency MBS have demonstrated relative stability, offering attractive risk-adjusted returns. The current environment favors investors seeking fixed income strategies with a degree of safety.

The Impact of Rising Interest Rates

Rising interest rates have a complex effect on Agency MBS.

1. Initial Price Decline: As rates rise, the value of existing MBS with lower coupon rates typically falls. This presents a buying opportunity for investors.
2. Higher Yields on New Issuances: Newly issued MBS offer higher coupon rates, reflecting the prevailing interest rate environment.
3. Slower Prepayments: Higher rates discourage refinancing, reducing prepayment risk and extending the duration of MBS.This is notably beneficial for investors seeking predictable income streams.

Volatility and Spread Widening

Recent market volatility has led to spread widening in the MBS market. MBS spreads – the difference between MBS yields and comparable Treasury yields – have increased, offering investors a premium for taking on prepayment risk. This spread widening is a direct result of investor uncertainty and a flight to quality.

Navigating Prepayment Risk in a Volatile Environment

Prepayment risk remains the biggest challenge for Agency MBS investors. However, several strategies can help mitigate this risk:

Duration Management: adjusting portfolio duration to align with interest rate expectations. Shorter duration portfolios are less sensitive to rate increases, while longer duration portfolios benefit more from rate declines.

Contraction Risk: Focusing on MBS with characteristics that make them less susceptible to prepayment, such as higher coupon rates and slower prepay speeds.

Diversification: Investing in a diversified portfolio of Agency MBS with varying coupon rates, maturities, and geographic locations.

Understanding PAC Bonds: Planned Amortization Class (PAC) bonds offer greater prepayment protection than standard MBS tranches, but typically come with lower yields.

Specific Agency MBS to Consider

Ginnie Mae Securities: Generally offer the highest yields due to their backing by the full faith and credit of the U.S. government. Frequently enough attract institutional investors.

Fannie mae & Freddie mac Securities: Provide a balance between yield and liquidity.Widely held by both institutional and retail investors.

* UMBS (Uniform mortgage-Backed Securities): Standardized securities issued by Ginnie Mae,Fannie Mae,and freddie Mac,enhancing liquidity and openness. A core component of many bond portfolios.

Real-World Exmaple: The 2022-20