Are Agency Mortgage-Backed Securities Making a Comeback?

Summary

Podcast Summary: Thoughts on the Market

Episode: Are Agency Mortgage-Backed Securities Making a Comeback?
Date: September 2, 2025
Hosts: Jay Bacow & Jim Egan, Co-Heads of Securitized Products Research, Morgan Stanley

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Episode Overview

In this episode, Jay Bacow and Jim Egan explore the current value opportunities in agency mortgage-backed securities (MBS), particularly considering the post-Jackson Hole environment. The hosts examine why mortgages are looking attractive relative to other high-quality assets, the impact of shifting Federal Reserve policy, and the evolving dynamics of supply and demand in the agency mortgage market.

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Key Discussion Points & Insights

1. The Policy Backdrop: Post-Jackson Hole Clarity

• Fed Policy Outlook:

  • The Federal Reserve is now seen as likely to cut rates in a “steady, almost programmatic fashion,” reducing uncertainty in the markets.
    • [00:22] Jim Egan: “After Jackson Hole, the Fed seems like it's leaning towards cutting rates in a steady, almost programmatic fashion.”

• Impact on Agency Mortgages:

  • The possibility of the Fed staying “on hold” had been a significant risk, but with that receding, the environment feels more supportive for agency MBS investors.

"One of the worst-case scenarios for agency mortgages... would have been the Fed staying on hold for much longer than expected. With that risk receding, the backdrop for investors owning agency mortgages feels a lot more supportive."
— Jay Bacow [00:40]

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2. Mortgages vs. Corporate Credit: Where’s the Value?

• Relative Valuation:
  • Corporate credit spreads are trading at their tightest levels in 20 years, while mortgages are at their 20-year average, offering relatively “cheap” yields for high-quality assets.

“Mortgages are basically at the average level of the past 20 years. Seems attractive to us.”
— Jay Bacow [00:40]

• Risk & Yield Balance:
  • Agency MBS, with their government guarantee, give investors a way to earn yield while minimizing credit risk.

“Investors are looking for places to earn yield without taking on too much credit risk. Mortgages, particularly agency mortgages with government guarantee there, they offer that balance, right?”
— Jim Egan [01:26]

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3. Shifting Demand: The Role of Fed, Banks, and REITs

• Previous Buyer Composition:

  • The biggest MBS holders (Fed and U.S. banks) have recently been net sellers or on the sidelines, leaving money managers and overseas investors as key buyers.

• Potential Shifts Ahead:

  • As the Fed signals rate cuts and market uncertainty falls, banks and possibly REITs may be incentivized to increase allocations to mortgages. Timing hinges on regulatory developments.

“With more clarity on Fed policy, banks in particular may get more comfortable adding mortgages to their balance sheets, though the exact timing depends on regulatory developments. REITs might also find this more compelling.”
— Jim Egan [02:15]

• Supply Side Dynamics:
  • Net issuance of conventional mortgages has been negative, a positive technical for the market. Other technicals, such as mortgage roll pricing, are improving.

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4. The Role of Rate Volatility

• Volatility as a Risk Factor:
  • Owning mortgages means being “short” interest rate volatility. Reductions in volatility since last year are supportive for MBS.

"If you're buying mortgages, you're inherently short rate volatility. And volatility has come down meaningfully since last year, even if it's still above pre-Covid norms. Lower volatility supported for mortgage valuations..."
— Jim Egan [02:50]

• Valuation Nuance:
  • Mortgages are not “cheap” per se, but valuations are attractive relative to other spread products, especially in the context of historically high equity prices and tight credit spreads.

"It's not about a snap tighter in spread. It's more about getting paid carry in an environment where spreads can grind in over time."
— Jay Bacow [03:56]

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5. Risks & Timing

• Potential Risks:

  • If credit spreads widen, mortgages would not be immune.
  • Regulatory uncertainty (e.g., Basel III proposals) may delay bank re-engagement.
  • Prepayment risk remains if rates fall unexpectedly.

• Outlook:

  • Agency MBS are likely to do well due to improving demand, supportive technical factors, and better clarity on Fed policy.

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Notable Quotes & Memorable Moments

• On Relative Value:

“When we look at high quality assets, we think mortgages look like the cheapest option.”
— Jay Bacow [00:40]

• On Fed’s Effect:

“The Fed's cutting rates, as we said, should incentivize investors to move out of cash and into securities.”
— Jay Bacow [03:13]

• On the Investment Thesis:

“Summing it up, mortgages look wide to alternative asset classes. The demand picture we think is going to improve and more clarity around the Fed's path is going to be supportive as well. All of that we think makes us feel confident this is an environment that mortgages should do well.”
— Jay Bacow [03:56]

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Timestamps for Important Segments

| Timestamp | Segment | |-----------|----------------------------------------------------------------| | 00:22 | Impact of Jackson Hole on Fed policy and market uncertainty | | 00:40 | Mortgages' relative value vs. other asset classes | | 01:26 | Mortgages as a balance of risk and yield | | 01:41 | Shifts in mortgage buyers and the supply-demand picture | | 02:15 | How bank and REIT demand could change | | 02:50 | Importance of interest rate volatility | | 03:13 | Valuations, risks, and the case for mortgages | | 03:44 | Risks, timing, and outlook summary |

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Tone & Style

The conversation is matter-of-fact yet optimistic, emphasizing analytical rigor with an eye on practical investment implications. Bacow and Egan maintain the clear, accessible language typical of Thoughts on the Market, focusing on giving actionable, insightful perspectives.

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Summary

Are agency mortgage-backed securities due for a comeback? Bacow and Egan argue yes, pointing to more favorable Fed policy, improving demand dynamics, and attractive relative valuations. The environment is shifting from uncertainty to opportunity for agency MBS—though investors should stay mindful of timing, regulatory developments, and residual risks. Key takeaway: agency mortgages offer the rare blend of yield and safety in a market where other spread products look expensive, making them a compelling option as the cycle evolves.

Transcript

[A]

Welcome to Thoughts on the Market. I'm Jay Bacow, co head of securitized products research at Morgan Stanley.

[B]

And I'm Jim Egan, the other co head of securitized products research at Morgan Stanley.

[A]

Today we're here to talk about why mortgages offer value after Jackson hole. It's Tuesday, September 2nd at 2pm in New York.

[B]

So Jay, let's start with the big picture. After Jackson Hole, the Fed seems like it's leaning towards cutting rates in a steady, almost programmatic fashion. And in prior episodes of Thoughts on the Market, you've heard different strategists at Morgan Stanley talk about the potential implications there. But for mortgages, what does this mean?

[A]

Well, it takes a lot of the uncertainty out of the market and that's a big deal. One of the worst case scenario for agency mortgages that the investors are buying, not mortgages that homeowners have, would have been the Fed staying on hold for much longer than expected. With that risk receding, the backdrop for investors owning agency mortgages feels a lot more supportive. And when we look at high quality assets, we think mortgages look like the cheapest option. Jim, you mentioned some of the previous strategists that come on Thoughts on the Market. Our global head of corporate credit strategy, Andrew Sheets had highlighted recently how credit spreads are trading at basically the tights of the past 20 years. Mortgages are basically at the average level of the past 20 years. Seems attractive to us.

[B]

And that relative value really does matter. Investors are looking for places to earn yield without taking on too much credit risk. Mortgages, particularly agency mortgages with government guarantee there, they offer that balance, right?

[A]

And it's not just that balance, but when we think about what goes into the asset pricing, the supply and demand picture makes a big difference in and that we think is changing. One of the reasons that mortgages have underperformed corporate credit is that when you look at the composition of the buyers, the two largest holders of mortgages are the Fed and domestic banks. The Fed's obviously going to continue to run their portfolio down. But domestic banks have also been on the sidelines. And that's meant that money managers and to a lesser extent overseas have had to be the largest buyers. But we think that could change. Right.

[B]

With more clarity on Fed policy, banks in particular may get more comfortable adding mortgages to their balance sheets, though the exact timing depends on regulatory developments. REITs might also find this more compelling.

[A]

Right. If the Fed's cutting rates, the front end is going to be lower and that's going to mean that the incentive to move out of cash should be higher and that's going to help both banks and likely REITs. But then there's also the supply side. Net issuance of conventional mortgages have been negative this year. That's obviously good. And some of the other technicals are improving as well. Rolls are trading better and all of this just contributes to a healthier landscape.

[B]

Right. And another thing that we've talked about when discussing mortgage valuations is the importance of volatility. If you're buying mortgages, you're inherently short rate volatility. And volatility has come down meaningfully since last year, even if it's still above pre Covid norms. Lower volatility supported for mortgage valuations, especially when paired with a Fed that's cutting rates steadily though. Jay, some of that already in the price.

[A]

Yeah, look, we didn't say mortgages were cheap, we just said mortgages are trading at the long term averages. But in an environment where stocks are near the all time high and credit's near the tights of the past 20 years, we do see that value. And the Fed cutting rates, as we said, should incentivize investors to move out of cash and into securities. Now there are risks. When valuations on other asset classes are as tight or as high as they are, you could see risk assets broadly underperform and mortgages are a risk asset. So if credit widens, mortgages would not be immune.

[B]

And timing is important here too. Right. Especially we think about banks coming back if they wait for full clarity on Basel III proposals that could be delayed. On top of that, there's prepayment risk.

[A]

Yeah, if rates rally, then speeds could pick up and investors are going to demand more compensation. But summing it up, mortgages look wide to alternative asset classes. The demand picture we think is going to improve and more clarity around the Fed's path is going to be supportive as well. All of that we think makes us feel confident this is an environment that mortgages should do well. It's not about a snap tighter and spread. It's more about getting paid carry in an environment where spreads can grind in over time. But Jim, we like mortgages. It's been a pleasure talking to you.

[B]

Pleasure talking to you too Jay. And to all of you regularly hearing us out. Thank you for listening to another episode of Thoughts on the Market. Please leave a review or a like wherever you get this podcast and share thoughts on the market with a friend or colleague today.

[A]

Go smash that subscribe button.

[C]

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