Gains in mortgage-backed securities are another reason to buy company debt

DEMAND for corporate bonds could get a boost from a surprising source in the coming months: investors taking profits on US mortgage bond holdings who need another asset to buy instead. 

Mortgage-backed securities have notched big gains this year of 0.45 per cent till last Thursday (Jan 15), outpacing most other forms of debt, after US President Donald Trump said that he is demanding that Fannie Mae and Freddie Mac buy another US$200 billion of the bonds. Risk premiums on mortgage-backed securities currently being produced have narrowed about 0.15 percentage point over that time, reaching their tightest level since 2022. 

That comes after a great run for mortgage bonds in 2025, with total returns of 8.6 per cent, the highest since 2002. Money managers including Allspring Global Investments and some Wall Street strategists are wondering if the tide will soon head the other way.

“We think these tight valuations in MBS (mortgage-backed securities) will prompt a sizeable rotation out of MBS and into competing products – obviously Treasuries given the lack of spread, but also back into corporate bonds,” wrote Hans Mikkelsen, credit strategist at TD Securities in a Jan 13 note. 

It is early days for any kind of a shift. For much of last year, money managers were making the opposite move, looking at using mortgage-backed securities as a place to hide from high valuations in corporate bonds.

Big companies such as Vanguard Capital Management and TCW Group said they are still partial to mortgage bonds, as spreads on corporate notes globally have reached their tightest levels since 2007.

The yield premium for corporate credit risk is stillvery narrow or inverted relative to agency mortgage-backed securities, said Peter Van Gelderen, TCW’s co-head of global securitised products. 

While valuations in the most liquid, generic parts of the mortgage-backed securities market are tight. For sophisticated active managers, some of the more esoteric market segments still offer attractive value, pointed out Brian Quigley, head of mortgage-backed securities and senior portfolio manager at Vanguard. 

This year could also see record sales of high-grade US corporate bonds, in part to help fund infrastructure for artificial intelligence. 

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But the comparative value may be shifting after the recent rally in mortgage bonds. Spreads on recently printed mortgage-backed securities are now much closer to risk premiums on higher-quality, intermediate-duration corporate bonds – the gap between the two sets of spreads has reached the lowest in about four years, indicated Bloomberg-compiled data. 

“The most recent mortgage-backed securities outperformance on Trump’s directive has reduced the relative attractiveness of the sector,” said Maulik Bhansali, senior portfolio manager and co-head of the core fixed income team at Allspring, who has trimmed his mortgage-backed securities position but remains “overweight”.  

Morgan Stanley last week lowered its view on mortgage bonds to “neutral” from “positive”, citing valuations. There are still reasons to like the securities, including potentially even more demand for Fannie Mae and Freddie Mac, and the likelihood that banks will face regulatory incentives to buy more of the bonds.

On the other hand, geopolitical concerns or policies that create more supply of mortgage bonds could weigh on returns, strategists Jay Bacow, Zuri Zhao and Janie Xue wrote in a note on Jan 13.  

Meanwhile, there are reasons to be bullish on credit even amid high valuations. Although corporate issuance will probably rise this year, US Treasury note and bond sales will likely fall sharply, meaning total fixed-rate bond sales could be about flat, said Barclays strategists. Investors may well move some money out of Treasuries and into company debt.

Global economic growth is still solid, with the World Bank last week having boosted its forecast for growth this year to 2.6 per cent from 2.4 per cent. That is a touch slower than the estimated 2.7 per cent growth for 2025, but still reflects resilience, said the lender. 

With mortgage bonds having gained so much in recent weeks, the upside may be limited, said Marc Bushallow, managing director of fixed income at money manager Manning & Napier Advisors. His firm has been cutting exposure to mortgage bonds for a few months. 

“There are other places where you can find better returns now,” Bushallow said.  BLOOMBERG