What The Rout In MBS Means For Pimco And Broader MBS Investor Alternatives, As The Market Wakes Up To Risk

Wonder why various PIMCO funds are getting hammered over the past week? Simple: the fund's recent push into mortgages, especially on margin, has backfired, and courtesy of the surge in mortgage rates which we highlighted yesterday, has left the world's biggest bond fund, second only the Federal Reserve, hoping for a last minute Hail Mary (Pimco can't print money unlike the former). As a reminder, while Pimco's TRF is positioned well to benefit from the steepening in the 2s10s courtesy of its 4.86 effective duration, we are unsure how the massive flattening of the 10s30s is impacting the firm. What we are absolutely sure of, is that the plunge in MBS prices in the recent week has left the fund gasping for air. Recall that the TRF has increased its MBS holdings by $50 billion in the prior two months (and likely continued in November), which is why the entire rates complex must prevent the ongoing rout in 10s and 30s as otherwise the negative convexity threatens to force an avalanche of selling first by the PIMCOs of the world, then everyone else. We present some very relevant commentary out of CRT on the MBS crunch conundrum.

From CRT:

MORTGAGE INVESTORS HAVE BEEN MORE SURPRISED BY THE TIMING AND MAGNITUDE OF THE RECENT INCREASE IN INTEREST RATES, RATHER THAN THE UPWARD DIRECTION. The sharp spike since just the end of November (6 trading days) has caused the effective duration of the overall Agency mortgage index to extend by a full year, or 38%. From an analytics perspective THE UP-IN-COUPON TRADE HAS BEEN HARDEST HIT, WITH "NEW" CONVENTIONAL 5.0% ISSUES LENGTHENING IN DURATION BY 54% (Yield Book data). Portfolio managers are in an especially tough position given that the move has occurred so late in the year. DO THEY NOW SET UP FOR 2011 WITH AN EXPECTATION THAT THE CURRENT TREND WILL BE SUSTAINED, ACCELERATE, OR BE REVERSED? Investors recognize that while "official" rates may remain close to zero, the rest of the curve is vulnerable - whether due to a better economic outlook or deficit pressures. There are several approaches to addressing such a view within a securitized products context - from resetting positions within the coupon stack, to adding more structure (CMOs/CMBS), TO LEAVING FRESH CASH ON THE SIDELINES THROUGH YEAR-END AND/OR UNTIL YIELDS MORE FULLY REPRICE.


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