Mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac and the Government National Mortgage Association rose to their highest level for the year on Wednesday, buoyed by strong demand from investors seeking a safe haven as the year draws to a close.
Risk premiums on these bonds were 3 basis points narrower at 124 basis points over the yields of comparable Treasuries. The previous narrowest level this year was 129 basis points in May.
"There's nothing else to buy," said Walt Schmidt, mortgage strategist at FTN Financial. "At yearend, people don't want to start to take on risk, and they are looking at staying close to the [benchmark Barclays Capital Aggregate Bond Index], and MBS make up 40% of the index."
In addition, the Federal Reserve remains a steady, daily buyer of these bonds.
While large holders of these bonds, notably Pacific Investment Management Co., have been paring their holdings of mortgage bonds, saying that risk premiums have tightened too much with little gains to be made, others say that mortgages offer safety at least for now. In the new year, however, concerns about the Federal Reserve's planned exit from this market may overshadow any gains.
Investors expect the Fed to stop buying these bonds at the end of the first quarter of 2010, ending the $1.25 trillion purchase program it started in January.
Since then, spreads have come down from 270 basis points over Treasuries. The central bank still has $228 billion more to spend on mortgages.
"Mortgages have tightened so much that people who were underweighting these bonds feel they are better off adding some back to their portfolios," said Art Frank, a strategist at Deutsche Bank.
Not everyone is sanguine about the mortgage market. Some participants, including Barclays Capital, are recommending that clients sell these bonds, arguing that "mortgages have tightened to unsustainable levels."