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Only Congress Can Spark Home Refi Wave, JPMorgan Says

Investors should continue buying mortgage bonds tied to U.S. home loans because they’re unlikely to suffer a wave of refinancings that would cut yields, according to JPMorgan Chase & Co.

Congressional action would be required to trigger any significant “government-sponsored refi wave” in the market for bonds owned or guaranteed by mortgage financiers Fannie Mae and Freddie Mac, JPMorgan analysts led by Matthew Jozoff wrote in an Aug. 27 note to clients.

“We continue to believe that such a large-scale event is highly unlikely,” wrote Jozoff, who is based in New York. “Fannie and Freddie could not unilaterally cut mortgage rates on existing private mortgages around the country, nor could the Treasury.”

Government-backed mortgage bonds rallied compared with U.S. Treasuries last week by the most since July 23, according to Barclays Capital index data. Too many mortgage refinancings would hurt bondholders by reducing the average interest rate backing securities they purchased. While applications to refinance existing mortgages are at the highest in more than a year, Jozoff said he doesn’t expect another major increase.

Mortgage bond buyers are being “well compensated for the prepayment uncertainty,” Jozoff wrote.

Fannie Mae, Freddie Mac and Ginnie Mae securities have returned 35 basis points, or 0.35 percentage point, less than U.S. debt this month through Aug. 27, even after narrowing the gap by 19 basis points last week, Barclays Capital indexes show.

Congressional Action

That’s the worst relative performance since November 2008 when the securities underperformed Treasuries by 0.68 percentage point amid the depths of the global financial crisis. Last month, the bonds returned 0.44 percentage point more than Treasuries, index data show.

“I wouldn’t say the market has completely dismissed these issues,” Jozoff said of a potential rise in refinancing in a telephone interview.

Only congressional action could force large-scale loan modifications on Fannie Mae and Freddie Mac-backed bonds, he wrote in the report.

“While we thought all along that the odds of the ‘nuclear’ refi option were low, we point out that the mechanics of implementing such a program are not quite as simple as a stroke of the pen,” he wrote.

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