The fixed income landscape is currently tricky for advisors and investors. There’s little clarity as to exactly when the Federal Reserve will lower interest rates — the hope is September. But the Treasury will need to continue printing money to serve this country’s soaring debt burden. That means yields on longer-dated bonds could rise, sending prices lower in the process. Still, some market observers see pockets of opportunity in the bond market. And those include mortgage-backed securities (MBS).
Exchange traded funds, including the WisdomTree Mortgage Plus Bond Fund (MTGP) provide access to MBS. The actively managed fund turns five years old in November; it sports a solid 30-day SEC yield of 3.84%. But it offers additional benefits.
Beyond yield, the case for MBS is supported by factors including favorable supply/demand dynamics as well as value. As an actively managed ETF, MTGP has the potential to more swiftly capitalize on valuation opportunities in the MBS space than its index-based rivals. That’s pertinent because MBS valuations are currently low.
Time Could Be Right for MBS, MTGP
As noted above, supply/demand dynamics in the MBS market are currently favorable. Some of that is attributable to higher interest rates.
“Rates on new mortgages are above 7%, limiting housing market activity which in turn is capping the supply of new MBS issues,” noted John Carey of BNP Paribas.
On the demand side of the equation, banks are wading back into the MBS market. But thus far, it’s mostly been in incremental fashion. Carey observed that when various regulatory guidelines are finalized and interest rates head lower, big banks could be big buyers of MBS. That could be a catalyst for MTGP over the back half of 2024.
Corporate Credit’s Strong Run May Be Ending
The credit quality of MBS – over 93% of MTGP holdings are rated AAA, AA or A – is pertinent. That’s because the low credit risk profile makes the assets suitable for banks to hold while complying with the Fed’s stress test guidelines.
Strengthening the case for MBS and ETFs such as MTGP is that the current climate could be more conducive to owning MBS over corporate credit.
“Relative to US corporate bonds, the current context favours US agency MBS. Yield spreads of corporate debt over US Treasury bonds have rarely been narrower since the Global Financial Crisis. Looking at developed credit markets more broadly we see signs of deteriorating fundamentals in the credit segment. This leads us to believe corporate credit’s strong run is coming to an end,” added Carey.
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