Portfolio Strategy

October 30, 2020

By the Numbers

Trading volume rises toward a 2020 peak

Brian Landy, CFA | October 30, 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.

MBS trading volume has grown steadily since the beginning of April and is approaching the peak levels of the year. The Fed, heavy mortgage refinancing and a pandemic boost in housing turnover from people looking to improve their work-from-home setting have all contributed. Net supply has exceeded the Fed’s buying over the past three months, but private investors have proven very willing to absorb the excess.

TBA trading is approaching levels last seen in March

TBA trading volume has steadily increased since the end of May (Exhibit 1). Volumes spiked in mid-March when the Fed began buying MBS for QE4, with Fed volume so heavy and consistent that it dampened the typical seasonality in TBA trading. Activity slowly returned to pre-pandemic levels as the Fed reduced the MBS it was adding to $40 billion a month, along with reinvesting portfolio runoff. The Fed now owns $2 trillion in MBS or 27% of outstanding supply. But trading has steadily increased since the end of May and is nearing March levels.

Exhibit 1: TBA trading volumes are approaching the high levels from March

The dark blue line is weekly trading volume, the light blue is fit using LOESS to smooth seasonal variation.
Source: Federal Reserve Bank of New York, Amherst Pierpont Securities

Mortgage originators routinely hedge originations with TBA contracts and roll those contracts to manage pipeline interest rate risk, so heavy origination can contribute to increased TBA and roll trading. Origination volumes have been extremely high in 2020 as many homeowners have refinanced into record low mortgage rates and many others have moved into larger homes that offer better work-from-home environments. Gross MBS issuance has already exceeded the previous high-level set in 2003 with three more months left in the year. Net issuance has averaged $33 billion a month this year and has averaged $52 billion per month for the last 3 months, exceeding the Fed’s net buying. The increase in trading activity has increased even faster since late October, perhaps as investors position for the upcoming election.

Dollar roll usage has rebounded to pre-pandemic levels

Dollar roll trading has also increased steadily over the past few months, recovering to levels set in late January and February (Exhibit 2). The Fed does not roll their positions, so the increase in activity comes from private investors. The roll has traded special in many coupons over the past few months, and investors that can roll their positions often chose to invest in TBA and roll rather than buy specified pools.

Exhibit 2: Dollar roll trading volumes are back to February’s levels

The dark blue line is weekly trading volume, the light blue is fit using LOESS to smooth seasonal variation.
Source: Federal Reserve Bank of New York, Amherst Pierpont Securities

Roll activity had spiked in late January and into February but slowed when the Fed began buying MBS for QE4. Roll trading remained suppressed until June but started recovering when the Fed slowed their pace of MBS purchasing. Heavy MBS supply and, over the last three months, a net increase in the amount of MBS held by private investors has contributed to heavier rolling. Activity increased despite weakening in the 2.5% and 3.0% rolls.

Brian Landy, CFA
1 (646) 776-7795
blandy@apsec.com

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