Trading activity in Fannie Mae 6% coupon mortgage-backed securities has skyrocketed ahead of the Federal Reserve's Federal Open Market Committee meeting this week and is expected to continue to swell after a decision on rates is announced Tuesday. More than $10 billion of FNMA 6s had changed hands in recent weeks as of late last Thursday, about double normal activity, according to traders. The demand led spreads on securities to tighten up to six basis points and traders predict they could still grind tighter. This trend is likely to continue because the market is persuaded that the Fed will increase rates gradually and in measured terms, said Paul Check, mortgage analyst at Deutsche Bank in New York.
Brian Cohane, mortgage-backed securities trader at UBS in New York, attributed the increased demand to two factors. He said banks are selling lower-coupon securities, such as 5% and 5 1/2% notes, and replacing them with 6s to cut duration and increase yield in one shot. This helps banks to shorten duration in anticipation of a rate hike and yet get an attractive yield, he explained. Cohane added hedge funds have also contributed to the rush and have been big buyers of 6s because of the attractive carry they offer.
Ken Hackel, fixed-income strategist at RBS Greenwich Capital Markets, concurred with these views and noted higher coupons have seen strong demand amid significant participation from banks, hedge funds and the agencies.
