Portfolio managers at Amundi Pioneer are making a bullish call on U.S. housing bonds.
Foreign buyers may be pulling up stakes at record levels when it comes to buying U.S. residential properties. But that doesn’t mean U.S. housing bonds, which have lagged behind the broader U.S. credit market, aren’t due for a rally.
“We are very constructive on the housing sector,” said Paresh Upadhyaya, Amundi Pioneer’s director of currency strategy, in an interview with MarketWatch. “U.S. housing will remain robust because you have consumer confidence near cycle highs and you have a 50-100-basis-point fall in mortgage rates from their recent peak.”
The average interest rate charged to borrowers of 30-year fixed-rate mortgages rose to a multiyear high of almost 5% in October, but since has retreated to about 3.81%, per this chart from Macrotrends, which shows how far home-loan rates have fallen since the 1980s.
Freddie Mac FMCC, +1.24% and Fannie Mae FNMA, +0.00% are two of the main U.S. government housing agencies, which have been providing a backstop to about 90% of the mortgage market since the 2007-’08 global financial crisis.
And while the agencies don’t make loans themselves, they do buy loans that conform to stricter standards and package that debt into so-called “agency” mortgage-backed securities, a massive $6.4 trillion market that is considered a surrogate to U.S. Treasurys because of it has government backing.
The bigger problem is rate fluctuations, which can impact housing bond prices, because borrowing rates often dictate if homeowners repay their mortgages faster or slower than anticipated.
Despite today’s low rates, and July being the heart of the traditional “homebuying season,” shares of the closely watched iShares Mortgage Backed Securities Exchange Traded Fund MBB, -0.03% were at $107.68 Monday, which is a discount to prices seen in two of the past five years.
The Federal Reserve is widely anticipated to cut rates later this month for the first time in a decade. But views are mixed as to the magnitude of the needed cut — a quarter or half point — at a time when the Dow Jones Industrial Average DJIA, +0.07% , S&P 500 index SPX, +0.28% and Nasdaq Composite Index COMP, +0.71% each have recently recorded all-time highs.
Uncertainty around monetary policy has put pressure on agency mortgage securities spreads, the level of compensation investors demand over a risk-free benchmark, which are currently near their widest levels since the global financial crisis, even as other parts of U.S. credit have rallied, according to Timothy Rowe, Amundi Pioneer’s deputy director of multi-sector fixed income.
“Year to date, spreads on agency MBS have widened 10 to 15 basis points, while spreads on investment-grade corporate bonds have tightened roughly 20 basis points, increasing the relative attractiveness of agency MBS,” Rowe said.
Another deterrent, until recently, for foreign buyers of U.S. dollar-denominated debt has been the high costs of buy protection against currency fluctuations.
But the growing pile of negative-yielding global debt also has helped bring borrowers back to agency MBS.
“Asian demand had been weak for much of the past year, though that trend has begun to reverse,” Rowe said.
And while Rowe does expect some initial indigestion as lower rates push more borrowers to refinance their home loans, he also expects a rally to follow in due course.
“Typically there is a two-month lag between originators selling new mortgages into the market and investors receiving the cash from the mortgages that were refinanced,” Rowe said. “Spreads on agency MBS are likely to tighten when these pressures ease.”