Mortgage Investors Brace for Post-Election Rate Volatility

(Bloomberg) -- Tuesday’s U.S. presidential has the potential to whip up interest rate volatility, presenting a danger to mortgage-backed securities.

After volatility surged 76% during October -- and closed Friday at its highest since April 23 -- market participants see the potential for it to move even higher. Morgan Stanley analysts on Friday pointed out that, judging by swaption market pricing, the election “is a 2.5 times vol multiplier.”

This may hurt MBS investors, as the chance of a borrower having an incentive to refinance is in part a function of interest rate volatility over the life of the loan. Homeowners refinancing mortgages give money back earlier than expected and at par, which would trigger a loss for those who purchased the securities at a premium.

Mortgages notched positive excess return of 0.12% in October, despite being on track to produce a loss midway through the month. The Federal Reserve’s support of the mortgage sector, however, undoubtedly played a role in helping it to end the month with a gain.

While the index overall ended with a gain in excess return of 0.12%, the Fed’s most favored coupon, the UMBS 30-year 2%, saw an excess return of 0.38%. Of the central bank’s $113 billion MBS purchases last month, that coupon alone made up 46% of the total.

Still, despite the Fed’s continued support, this presidential election brings with it more uncertainty than any seen in decades. Investors like uncertainty least of all.

Nomura MBS analysts warned on Friday that a jump in interest rate volatility post-election is a key near-term risk.

• Christopher Maloney is a market strategist and former portfolio manager who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice

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