(Bloomberg) — Growing turmoil in the bond market and fears of rising US inflation are hitting agency mortgage bonds particularly hard. To investors at Janus Henderson and Columbia Threadneedle Investments, this weakness could present opportunities to buy the securities.
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Spreads, or risk premiums, on recently produced agency mortgage bonds have widened by about 0.3 percentage point since mid-September to 1.54 percentage points over a blend of Treasury bonds. That’s the widest since early July.
Bond yields, meanwhile, have been climbing in recent weeks, potentially because of markets’ growing perception that Donald Trump could win, Republicans could gain control of both houses of Congress, and government borrowing might surge amid more tax cuts.
Mortgage bonds get hit hard when there’s growing uncertainty about the direction of rates, because their returns depend so much on it. That path determines how likely homeowners are to refinance their debt and hand back principal to investors early. Uncertainty is high now: an index tracking interest-rate volatility has risen to close to its loftiest level in about a year.
Questions about the trajectory of interest rates might fade after the election, said John Kerschner, head of securitized products at Janus Henderson. In the meantime, mortgage-backed securities are relatively cheap, he said.
“Mortgage bonds looks very attractive versus high-grade credit currently but the timing of the trade is paramount,” Kerschner said. “It could be a rocky road for the next few weeks before it pays off.”
Much depends on how the US elections actually turn out, which at this point is an open question. Former President Donald Trump and current Vice President Kamala Harris are locked in a dead heat. Which parties end up with control of the Congress will determine how likely either president is to enact their policies.
The worst outcome for MBS could be a Republican sweep of the presidency and Congress, said Erica Adelberg, a senior mortgage bond strategist at Bloomberg Intelligence.
“Policies such as tariffs, fiscal stimulus from tax cuts, and as a result deficits — those are going to be much more dramatic in a Trump presidency,” Adelberg, author of a recent note, said. “Because higher volatility may hurt MBS performance, MBS investors should be paying attention.”
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