High-Interest Mortgages Drive Volatility in US MBS Market
The US mortgage-backed securities market faces increased volatility as mortgages with rates of 5% or higher now exceed 40% of unpaid principal balances.
The U.S. mortgage-backed securities (MBS) market is experiencing heightened volatility due to a significant shift in the composition of mortgage interest rates. Data from Intercontinental Exchange indicates that mortgages with rates of 5% or higher grew from 10% of unpaid principal balances at the end of 2022 to more than 40% by July 2026.
This trend creates a dual risk for investors. A larger pool of borrowers is now positioned to refinance if interest rates drop, which increases prepayment risk. Conversely, if the Federal Reserve System tightens monetary policy and rates rise, the duration of these bonds lengthens, making their prices more sensitive to rate hikes.
Strategists from FHN Financial Securities and Morgan Stanley warn that the market may be complacent regarding the speed of loan repayments. They specifically highlight the potential for artificial intelligence to streamline the refinancing process, which could lead investors to misprice borrower options and the resulting speed of prepayments.
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