State Street and Voya Pursue Risk Mitigation Strategies Amid Default Concerns

Mortgage Bonds Gain Attractiveness as Corporate Debt Risks Rise

Key Takeaways:

• Rising energy prices and inflation fears have made corporate bonds increasingly risky, prompting big money managers to consider mortgage bonds and other securitized debt as alternatives.
• Mortgage bonds often perform better than US high-grade corporate debt in "risk off" markets, as they are getting extra support from Fannie Mae and Freddie Mac.
• State Street and Voya Investment Management have been overweight mortgage bonds and other securitized debt relative to benchmarks for much of the past year.

Market Trends:

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• US high-grade corporate bond spreads have widened by about 0.17 percentage point from their Jan. 22 lows, while mortgage bonds have gained a bit, according to Bloomberg index data.
• The gap between the current production mortgage bond spread and the high-grade corporate bond spread was around 0.33 percentage point as of Thursday's close, a relatively cheap position for mortgage bonds.
• A measure of the volatility of mortgage bonds has been declining in recent days, making them more attractive as a safe-haven asset.

Risks and Considerations:

• The trade of favoring mortgage bonds and other securitized debt over corporate debt carries risks, including a potential snapback in high-grade credit spreads if the war in Iran ends or the Trump administration pulls back from the conflict.
• Energy prices may continue to create inflationary pressure and doubt about the future direction of rates, affecting both corporates and mortgage bonds.
• Credit faces other pressure too, including artificial intelligence disrupting software companies, and private credit potentially facing growing losses.

Expert Insights:

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• Matthew Nest, global head of active fixed income at State Street Investment Management, believes mortgage bonds look attractive from a relative value standpoint compared with corporate bonds.
• Tony Trzcinka, portfolio manager at Impax Asset Management, warns that the moment the war in Iran ends, or the Trump administration pulls back from the conflict, high-grade credit spreads could snap back quickly.
• David Goodson, managing director and head of MBS at Voya Investment Management, suggests that in a world like today, MBS offers an appealing source of diversification.