Boston - Eaton Vance and its affiliates seek to actively capitalize on opportunities presented by volatile investor sentiment, while ensuring that the portfolio risk profile remains appropriate for the specific strategy. The following are excerpts from a recent conversation with Andrew Szczurowski, CFA, Portfolio Manager at Eaton Vance Management.
What we are seeing: While the decline in economic growth likely bottomed in May, it remains to be seen how quickly the economy recovers. Risk markets seem to be a little more optimistic than our team and the US Federal Reserve, which updated its economic projections at the June 10 meeting. The Fed does not see US GDP getting back to February levels until sometime in 2022, and predicts unemployment ending this year near 10%. Given the Fed's view that the economy will take a while to get back to pre-COVID-19 GDP levels, it also likely means that policymakers will err on the side of too much rather than too little stimulus.
Agency mortgage-backed securities (MBS) have been one of the primary asset classes that the Fed has been buying to stimulate the US economy through lower mortgage rates. The Fed has purchased roughly $700 billion over the past 2.5 months, and committed at last week's meeting to maintaining purchases at least at the current pace. This came as a surprise to the market, which was expecting purchases to taper off slightly.
What we are doing: We know the Fed is trying to pull down mortgage rates to stimulate economic growth. With the Fed's unlimited checkbook behind the cause, we believe MBS spreads are likely to tighten relative to Treasurys, which would also lead to lower mortgage rates. This could lead to faster prepayments on plain-vanilla MBS as borrowers refinance. To protect our investors, we have been rotating into specified pools of agency MBS that we believe have greater protection against refinancing waves — potentially offering cheap call protection with lots of upside if banks begin to tighten credit.
What we are watching: We are watching the spring home selling season, which was delayed in many parts of the country due to the COVID-19 induced lockdown. For now, it seems there is a shortage of homes on the market, which keeps upward pressure on home prices. If the supply of existing homes picks up as we get into the summer, it could cause the home price appreciation that these areas have experienced for nearly a decade to start fizzling out. If banks become concerned that home prices are no longer rising, they could begin to restrict credit to borrowers with lower credit scores, leading to slower mortgage prepayments on certain bonds.
Final word: Agency MBS look very compelling relative to US Treasurys, with spreads sitting well above their five-year average, and the Fed — the largest holder of agency MBS — buying bonds daily. To capture the upside potential from the asset class, given the Fed's goal of lowering mortgage rates, we believe investors need to protect themselves from faster prepayment speeds by investing in MBS that might be insulated from a refinancing wave.