The uncertainty of the presidential election—however long that lasts—is bound to incite interest rate volatility, something that presents a peril to the mortgage-backed securities (MBS) market, according to Christopher Maloney, a market strategist and former portfolio manager who writes for Bloomberg.
In October, volatility surged 76%. Last Friday it closed higher than it has since April 23, and experts say it could keep rising. Morgan Stanley analysts called the election “a 2.5 times vol multiplier," he noted, adding that, "This may hurt MBS investors, as the chance of a borrower having an incentive to refinance is in part a function of interest rate volatility over the life of the loan. Homeowners refinancing mortgages give money back earlier than expected and at par, which would trigger a loss for those who purchased the securities at a premium."
In October, mortgages recorded a positive excess return of 12%, even though they were on a path halfway through the month to produce a loss.
Writes Maloney, "The Federal Reserve’s support of the mortgage sector ... undoubtedly played a role in helping it to end the month with a gain."
While the index overall ended with an excess-return gain of 12%, "the Fed’s most favored coupon, the UMBS 30-year 2%, saw an excess return of 38%. Of the central bank’s $113 billion MBS purchases last month, that coupon alone made up 46% of the total," he wrote.
Maloney goes on to explain why the current indecision could impact MBS risk in the period to come.
"Despite the Fed’s continued support, this presidential election brings with it more uncertainty than any seen in decades. Investors like uncertainty least of all."
MBS analysts at NOMURA warned on Friday that an interest rate volatility hike, post election, is a key near-term risk, according to Maloney, whose article can be read in full on Bloomberg | Quint.