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| Peter Wilson |
How would you describe the current state of the fixed-income market? The corporate bond market has strong fundamentals and uncertain market technicals. By strong fundamentals I mean companies have strong balance sheets and good cash flow. The uncertainties are related to terrorism and geopolitical developments, the election cycle in the U.S. and the sustainability of the economic recovery. There is a spread-widening risk in corporates.
What's your outlook for the mortgage-backed securities market?
Mortgages are driven by swap spreads and volatility; swap spreads are related to corporate bond spreads. Corporate spreads face spread-widening risk and so swap spreads are also subject to widening risk. Historically, a flattening curve is associated with widening swap spreads. This is bad for mortgages relative to Treasuries. Mortgages are doing well because implied volatility is low, because the market is confident of the measured action of the Federal Reserve.
Will mortgage spreads widen?
Only if volatility goes up. There is nothing within the mortgage market that will drive up volatility. There is no big convexity risk But if there is to be a rally of 50 basis points from here, that will be a different story. That will lead to a rise in implied volatility. The mortgage market has not priced in uncertainty in the Fed's action.
What offers value within the MBS market?
Non-agency MBS offer value and are more interesting. Whole loans offer value at different times even though you give up some liquidity. It is an issuer-by-issuer, deal-by-deal thing. Non agency MBS has a role in the portfolio, while whole loans provide extra yield for loss of liquidity. Agency MBS have traded cheaper relative to swaps for a while now. There is a spread roll down opportunity as you go out. However, agency MBS will continue to remain a headline risk. I don't see government-sponsored enterprise issues going away politically. You have to be willing to deal with it if you are getting involved in it in a big way.
Are these serious concerns?
GSE issues are a concern. They are so big and it is hard to ignore [these issues] being there. Washington will continue to focus on them. Whether Washington will do anything in the immediate future is not clear, but ultimately the growth of the GSEs will be limited. As a result, MBS in generally will grow slowly and become richer.
What is the significance of Fannie Mae's recent disclosure about its exposure to mortgage derivatives?
Fannie and Freddie are well-managed entities and I don't think there is any real risk in their exposure to derivatives. The question is whether these agencies should be involved in the sub-prime and commercial mortgage-backed securities markets.
How do you view Wall Street research?
This market may not be the most efficient in research. There are not many analysts these days, in fact there are far fewer than there were just a few years ago. It is the same information over and over again. We do, however, use Street research. We are information collectors and processors. We gather as much information as possible and use that to make informed decisions. We also have our own in-house research and are committed to fundamental credit research and quantitative analysis.