Mortgage-backed security volatility hits taper-tantrum levels

This year's mortgage-backed securities volatility has hit a new level due to sharp intraday jolts to the broader market from increased global inflation uncertainty, which escalated in the wake of U.K. tax cuts late last week.

The intraday moves were similar in magnitude to those early in the pandemic and during the so-called taper tantrum in 2013, when the Fed first surprised the market with scaled-back bond buying, FHN Financial reported Tuesday.

Current coupon 30-year MBS spreads to the five- and 10-year Treasury blend have recently been in a range above 170 basis points last seen during the COVID-19 breakdown, confirmed Justin Hoogendoorn, senior managing director at Hilltop Securities.

"MBS spreads have widened massively in the past couple of days," said Hoogendoorn. "Mortgages are simply trying to find a floor, along with the rest of the fixed-income market."

When asked about the drivers, Walt Schmidt, senior vice president, mortgage strategies at FHN Financial, said it was the culmination of a lot of factors that, in tandem with the United Kingdom's move, spurred concerns that "central banks around the world have reached their limits in terms of how much they can control the market when inflation is a problem."

The spread widening followed a period when the MBS market got a short-term lift from the Fed's announcement that it wouldn't be transitioning from allowing its bond portfolio to run off into outright sales any time soon, and reversing those gains.

The escalation in volatility has led to some difficulty in determining how to price loans, according to an early Tuesday morning report from Transformational Mortgage Solutions.

"Good luck making rate sheets," it read.

A little later on Tuesday, things did seem a little calmer, with spreads marginally tighter, Schmidt said.

The MBS market has generally been going through a lot of fluctuation this year and it looks likely to continue.

Schmidt said excess returns for mortgages relative to Treasuries, a measure which is largely a pricing metric, illustrate this point: in April, they lagged by 105 basis points; by May, they'd outperformed by 70 followed by June, down 63; July, up 129; August, down 100; and through Monday evening in September, down 280.

"There has been a tremendous amount of performance volatility the last six months, mostly to the downside; but there have been two months, particularly May and July, where we had big snapback opportunities," said Schmidt.

Schmidt and Hoogendoorn both expect the market could be rocky for a while. Monetary policymakers have indicated they are looking for market shocks as a way to potentially get inflation under control.

"It may simply take more of a market washout before we can experience the stability that so many market participants seek," Hoogendoorn said.