Don't forget Mac and Mae
MBS issued by U.S. housing agencies could have advantages for investors if the economy slows.
While not an investing slogan per se, a high chance of recession argues for high-quality bonds.
Naturally, U.S. Treasuries come first to mind. Yet they are not the only haven trade. Mortgage-backed securities (MBS) guaranteed by the three U.S. housing agencies are among the world’s safest investments. Ginnie Mae mortgages carry an explicit “full faith and credit” government guarantee, and those of Freddie Mac and Fannie Mae benefit from implicit support. In the burst of the housing bubble and subsequent Global Financial Crisis, agency MBS were paid in full. Furthermore, this market boasts excellent liquidity—trailing only Treasuries. Dealers can absorb the sale of $5, $50 even $100 million of securities.
For short-duration agency MBS, the Federal Reserve’s tightening cycle has created an environment of “Have your cake and eat it, too.” Yields are historically high relative to Treasury bills and notes of comparable duration. And recently, spreads—the difference between these yields—have been as wide as 50 to 100 basis points for different types of floating-rate government MBS.
For investors in the short-end of the Treasury yield curve and agency market, then, the focus is on the moving target that is the fed funds rate. The Federal Open Market Committee’s skip of a hike at its last meeting now looks like a jump toward an increase in July’s. Its last “dot plot” showed that a majority of voters expect to increase the target range at least 25 basis points in the rest of the year and not ease until 2024. The longer they hold at the terminal rate, the more Treasuries and MBS should benefit. In this environment, a portfolio of securities maturing in less than two years has the potential for more income than one with those maturing beyond that time period.
The yield curve, currently inverted, should eventually re-steepen, with high rates at the short end having more scope to fall than those at the longer end. When that occurs, having a concentration of short-duration securities relative longer-duration ones likely will benefit investors. The short end of the yield curve is the most attractive maturity bucket at present, but moving some assets from cash to short-duration MBS seems to be a strong play for investors.