Mortgage Bonds Head to Biggest Gains Since 2008 in Reversal

Government-backed U.S. mortgage securities are poised for their biggest monthly gains since 2008 after posting their first annual losses in 19 years, as investors seek havens amid turmoil in developing nations.

Returns in the $5.4 trillion market averaged 1.5 percent in January through yesterday, the largest advance since a 1.7 percent gain in December 2008, according to Bank of America Merrill Lynch index data. The debt lost 1.4 percent last year as investors braced for the Federal Reserve to slow its buying of the bonds and of Treasuries, reductions that began this month.

Agency mortgage securities soared with U.S. government notes amid a rout in emerging markets from Argentina to Turkey and signs of weakness in the world’s two biggest economies even as the Fed said it would make additional cuts to its purchases next month. The central bank’s persistent buying is also supporting the market after a drop in new lending.

The “Fed demand remains formidable despite the tapering,” Anish Lohokare and Timi Ajibola, strategists in New York at BNP Paribas SA, wrote yesterday in a report.

Comments by a Treasury Department official suggesting limits on any potential expansion of a Fannie Mae and Freddie Mac refinancing program for homeowners with little or no equity separately helped boost higher-rate securities.

Securities Rally

Gains in lower-coupon bonds used to package new loans helped push the average rate on a typical 30-year mortgage down to 4.32 percent in the week ended yesterday, from 4.48 percent in the last week of 2013, according to Freddie Mac surveys.

The securities rallied further today. A Bloomberg index of yields on Fannie Mae’s so-called current-coupon 30-year bonds fell 0.04 percentage point to 3.34 percent as of 5 p.m. in New York. That’s the lowest closing level since Nov. 19, when mortgage rates averaged about 4.25 percent after reaching a two-year high of 4.58 percent in August.

A rise in borrowing costs from a record low of 3.31 percent in November 2012 has depressed homeowner refinancing, pushing applications for new loans down by 57 percent from last year’s high in May, according to Mortgage Bankers Association data. The Fed’s additions of mortgage bonds to its balance sheet declined $5 billion this month to $35 billion and will fall $5 billion next month, a total drop of 25 percent.

Fannie Mae’s 4.5 percent securities rose to 107.3 cents on the dollar from 106 cents on Dec. 31 after Michael Stegman, the Treasury’s chief housing-finance adviser, said the agency opposes extending the Home Affordable Refinance Program to mortgages made after mid-2009. An expansion of HARP might lead to the debt’s principal being returned faster at par.

Agency mortgage bonds have returned 0.14 percentage point less than similar-duration government notes in January, the Bank of America Merrill Lynch index data show.

“While mortgages have lagged the flight-to-quality into Treasuries,” the securities are among assets with “minimal credit risk” that are likely to catch up if investors remain wary, the BNP analysts wrote.

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