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Sell 30-year 2.0%s, pick up carry or convexity in 15-year paper
admin | July 31, 2020
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Portfolios that can use the TBA dollar roll can move from 30-year 2.0% into 15-year 1.5% pass-throughs and pick up valuable carry. For portfolios that cannot use the dollar roll, including most banks, moving from 30-year 2.0%s into 15-year 2.0%s picks up better convexity at a small concession in spread.
Par 30-year paper tightens to par 15-year
Since the beginning of July, the 30-year par MBS spread to the Treasury curve has tightened more than 16 bp with the 15-year par spread in only 2 bp. That has left 30-year pass-throughs tight to 15-year (Exhibit 1). In fact, 30-year paper has closed tighter to 15-year paper in less than 10% of trading sessions over the last five years.
Exhibit 1: The par 30-year pass-through in July tightened sharply to the 15-year
Source: Bloomberg, Amherst Pierpont Securities
Still tight after adjusting for the yield curve
Of course, 30-year pass-throughs trade off a longer part of the yield curve than 15-year pass-throughs, so a flattening of the yield curve could tighten spreads without indicating a change in relative value. It is important to adjust for the slope of the yield curve. After adjusting, 30-year paper still shows as tight (Exhibit 2).
Exhibit 2: Par 30-year paper still seems tight after accounting for yield curve slope
Source: Amherst Pierpont Securities
Weighing the dollar roll
Investors can now pick up the better convexity of 15-year pass-throughs with a narrow concession in spread. However, the details of the dollar roll in TBA 30- and 15-year pass-throughs are important for constructing the trade, as is the ability of the investor to roll the position.
Both TBA 30- and 15-year pass-throughs closest to par now roll special in light of the Fed’s steady bid, offering extra carry for portfolios that roll the position (Exhibit 3). The FNCL 2.0%s roll 2.75/32s special from August to September, the FNCI 2.0%s roll 1.50/32s special, and the FNCI 1.5%s roll 4.35/32s special. The best position in these coupons depends on a portfolio’s ability to roll.
Exhibit 3: Pass-through nearest to par in 30- and 15-year MBS currently roll special
Note: All market levels as of 7/30/20, 10:50 AM. Assumptions for roll calculations include a 0.13 cost of funds, 2 CPR prepayment rate and a 0.13 reinvestment rate. Source: Bloomberg, Amherst Pierpont Securities.
For portfolios that can dollar roll, the 15-year 1.5% paper looks the best as long as the special roll persists. Steady Treasury rates and a likely declining primary-secondary mortgage spread should mean steady production of FNCI 1.5% paper, a steady Fed bid and, consequently, a special roll.
For portfolios that cannot dollar roll, the 15-year paper 2.0% paper looks like good relative convexity at an inexpensive price. Taking TBA-quality FNCL 2.0% pools means the non-rolling investor is implicitly paying for prospective future special financing that the portfolio cannot use. The same holds for TBA-quality FNCI 1.5% pools. Find some inexpensive FNCI 2.0% specified pools and hold them.
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