logo
  Join        Login             Stock Quote

Mortgage Hedging Unlikely To Boost Treasury Yields

 February 27, 2013 10:07 AM


(By Mani) The market is abuzz with talk that Treasury yields are nearly high enough to cause a surge in hedging activity as mortgage convexity hedging was a bogeyman for much of the 1990s and 2000s.

However, rising Treasury yields and swap rates could cause mortgage durations to extend, leading mortgage hedgers to enter pay-fixed swaps, which in turn would put more upward pressure on rates.

Conversely, when yields fell, durations would shorten, and hedgers would execute receive-fixed swaps, thereby accelerating the drop in rates.

"Definitely a vicious circle. In our opinion, the bogeyman is not ready to return," UBS strategist Mike Schumacher said in a note to clients.

Convexity, which refers to the inverse relationship between the value of a fixed-income instrument and its yield, helps to measure and manage the amount of market risk to which a portfolio of bonds is exposed.

[Related -Six Stocks that Could Outperform in the next 90 days]

When the convexity is high, risk to which the portfolio is exposed also increases and when it becomes vice versa, the bond portfolio can be considered hedged. Investopedia says the higher the coupon rate, the lower the convexity (or market risk) of a bond. This is because market rates would have to increase greatly to surpass the coupon on the bond, meaning there is less risk to the investor.

Mortgages are usually hedged by selling Treasury securities. As a result, interest rate variations coupled with the duration of mortgage backed securities is expected to have a snowball effect on bond rates.

When the duration of an MBS product extends, the market participants try to re-balance hedges by extending their short Treasury positions.

[Related -Foot Locker, Inc. (FL) Q2 Earnings Preview: Running Past the Street View]

"Our rule of the thumb is that 10-15% of MBS duration shifts are delta-hedged with interest rate swaps. Consequently, the MBS hedging need this year should approximate selling $30-50 billion 10yr Treasuries," Schumacher noted.

In this scenario, actual re-balancing flows have been far smaller than the theoretical hedging requirement. Some mortgage players could decide to catch up, and initiate substantial transactions.

"We doubt it will happen soon. Furthermore, convexity will continue to moderate if yields increase," Schumacher said.

As a result, the much feared upsurge in mortgage hedging probably will not occur even if Treasury yields rise another 20-30 basis points.

Currently, yields on the benchmark 10-year Treasury bond fell 7 basis points to 1.88 percent. Last Monday, the yield reached 2 percent.

iOnTheMarket Premium
Advertisement

Advertisement


Post Comment -- Login is required to post message
Name:  
Alert for new comments:
Your email:
Your Website:
Title:
Comments:
 

rss feed

Latest Stories

article imageMBIA Inc. (MBI) : BTI's $12 a Tough Task

MBIA Inc. (NYSE:MBI) is doing well on a day stocks are struggling The guarantee insurance company is the read on...

article imageUrban Outfitters, Inc. (URBN) Q2 Earnings Preview: A Snug Fit

Urban Outfitters, Inc. (NASDAQ:URBN) will hold a webcast to discuss its second quarter of fiscal-year 2015 read on...

article imageEstee Lauder Companies Inc. (EL) Q4 Earnings Preview: Options Player Betting On EL’s EPS Looking Pretty

Estee Lauder Companies Inc. (NYSE:EL) will release fiscal 2014 fourth quarter and full year financial read on...

article imageHerbalife Ltd. (HLF): 3 Reasons To Pay Attention to Recent Insider Buying

Well, well, well… it looks as if boardroom buyers viewed the recent selloff as an opportunity to buy. read on...

Advertisement
Popular Articles

Advertisement
Daily Sector Scan
Partner Center



Fundamental data is provided by Zacks Investment Research, and Commentary, news and Press Releases provided by YellowBrix and Quotemedia.
All information provided "as is" for informational purposes only, not intended for trading purposes or advice. iStockAnalyst.com is not an investment adviser and does not provide, endorse or review any information or data contained herein.
The blog articles are opinions by respective blogger. By using this site you are agreeing to terms and conditions posted on respective bloggers' website.
The postings/comments on the site may or may not be from reliable sources. Neither iStockAnalyst nor any of its independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. You are solely responsible for the investment decisions made by you and the consequences resulting therefrom. By accessing the iStockAnalyst.com site, you agree not to redistribute the information found therein.
The sector scan is based on 15-30 minutes delayed data. The Pattern scan is based on EOD data.