Over the past weeks, fluctuations in the mortgage-backed securities (MBS) market played a prominent role. Investors have shown an unusual dynamic, oscillating between extreme caution and confident optimism. This pattern reflects both external influences and the inherent characteristics of the MBS market.
It’s no secret that many investors continue to monitor the MBS market with fascination and vector diagrams. But what’s the intrigue? Basically, mortgage-backed securities are a type of investment security, a bond, backed by a pool of mortgages on a real estate asset such as a house. There are more types of MBS, but in this recap, we’ll just focus on agency MBS. These are issued by Government Sponsored Enterprises (GSEs), such as Fannie Mae, Freddie Mac, and Ginnie Mae. As most might know, these securities play a pivotal role in determining mortgage rates for homeowners.
It’s important to keep in mind that the world of MBS isn’t isolated. Everyday events may heavily affect its progress and performance. Geopolitical tensions, significant milestones in international business, legislative changes, and domestic trends are among the factors that directly impact MBS investment decisions.
Now onto the specific events which have often led to these volatile market trends. Let’s rewind back to the weeks leading up to Christmas (2019). The MBS market presented more ups and downs than the Rocky Mountain range. It was a result of the combined effect of a series of events – the year-end liquidity squeeze, holiday short-covering, and most interestingly, the geopolitical tension with Iran.
To understand the finer details, the ‘year-end liquidity squeeze’ referred to here is a phenomenon that occurred because banks want their balance sheets to appear as sound and healthy as possible at year-end. This ‘clean-up’ happens as banks purchase government and agency debt (including MBS) to shrug off riskier assets, which puts pressure on MBS yields and thus drops mortgage rates.
Simultaneously, holiday short-covering was also in full dynamic. When traders sell bonds short, they’re betting that bond prices will fall (yields rise). However, if they’re wrong and prices rise, they incarnate a loss. Over the holidays (when trading volumes are typically lighter), the risk of short-covering-induced price spikes increases. Therefore, traders pre-emptively buy bonds, pushing prices higher.
The final compounding factor here was increasing geopolitical tensions chiefly featuring Iran. As a general rule, geopolitical risks make other countries’ investors store their money in ‘safer’ spaces. For many, US bonds represent one of these ‘safe-havens’. As a result, these events usually stimulate a surge of buying in the bond sector.
Rewinding further to the period around mid-December, major news broke confirming a phase-one trade deal between the United States and China. This significant milestone lifted investors’ spirits and led to a surge of optimism. The immediate impact on the MBS market was a rise in treasury yields, reflecting a decrease in bond prices and an increase in mortgage rates. This demonstrated the direct linkage between global events and domestic mortgage rates.
However, this surge of optimism was short-lived. Toward the tail end the month, investors’ confidence began to wane. They stopped selling safer bonds in favor of riskier stocks, and mortgage rates began to drop again.
As we moved into the early days of the New Year, the market was trapped in a volatile loop as the tension between the U.S. and Iran escalated to new heights. The MBS market, being sensitive to geopolitical events and fluctuations, experienced another roller-coaster ride. A peak was reached on January 3rd, when airstrikes in Iraq resulted in the assassin of Iranian general Qasem Soleimani. This event thrust the market into an unpredictable state as investors scrambled to react.
What ensued next were several days of fluctuating MBS yields. Initially, there was a sharp drop, as investors fled riskier stocks in favor of bonds. But as the days passed and it became apparent that an all-out war was unlikely, yields slowly recovered, and mortgage rates rose. Meanwhile, the housing market showed upbeat data indicating new home sales remaining strong. This positive news bolstered investor confidence and nudged MBS yields further up.
Fast forwarding to January 8th, a day that marked a ceasefire in the Middle East following a retaliatory Iranian missile strike on Iraqi bases housing U.S. troops. This news invited optimism back into the MBS market, which saw a recovery of treasury yields to pre-Soleimani-assassination levels. The housing market continued to perform solidly, backing up investor confidence.
In conclusion, the MBS market enters 2020 as a formidable scene of action, packed with uncertainties, reactions, and adaptations, reflecting global events with home mortgage rates. Investors will need to stay on their toes and keep a vigilant eye on global news, international relations, governmental policies, and general market trends.
The MBS market offers a unique blend of intense action and acute sensitivity, both reacting to and influencing the larger financial ecosystem. As such, understanding the market demands a focus on the role global events play in sparking reactions and influencing patterns. Keep an eye on the horizon – 2020 is set to be a notable year for MBS market observers, participants, and homeowners alike.