On September 18, the Federal Reserve (Fed) lowered interest rates for the first time since March 2020,1 choosing to cut its policy rate by 50 basis points (bps) in what Fed Chair Powell characterized as a “recalibration of our policy stance.”2 Prior to the Fed’s decision, markets had been split on whether the cut would be 25 or 50 bps. Mortgage-backed securities (MBS) reacted favorably to the larger rate cut initially, with MBS spreads tightening on the belief that Fed policy was now favoring lower and less volatile interest rates.3
Today’s Chart of the Week shows the option-adjusted spreads (OAS) for MBS and investment-grade corporate bonds alongside the 10-year Treasury yield. Since the Fed’s 50-basis-point cut on September 18, Treasury yields have risen, MBS spreads have cheapened and corporate credit spreads have richened. Stronger-than-expected economic data over the past month has pushed Treasury yields higher as market participants price in a slower pace of Fed easing and inflation concerns reemerge. The rise in yields and resilience of the U.S. economy have driven demand for corporate credit with the OAS on the corporate credit index last week hitting its lowest level post-Global Financial Crisis.4 The MBS index — which consists of residential mortgages backed by the U.S. government — has widened in OAS over the same period as the rise in Treasury yields have driven interest rate volatility higher.5
Key Takeaway:
The rise in interest rates over the past month has caused MBS valuations to cheapen and look attractive relative to Treasuries and U.S. corporate bonds. However, the continued resilience of the U.S. economy and possibility of additional fiscal stimulus coming out of the U.S. election could continue this trend in interest rates and prevent MBS valuations from improving.
Sources:
1CNBC – The Federal Reserve just cut interest rates by 50 basis points—here’s what will get cheaper; 9/18/24
2Federal Reserve Board – Transcript of Chair Powell’s Press Conference September 18, 2024
3-5Bloomberg
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This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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