The Warsh Effect on Mortgages

Summary

Morgan Stanley's securitized products research co-heads discuss how Fed Chair Warsh's less-forward-guidance approach and the market's pivot from rate-cut to rate-hike expectations increase uncertainty and volatility, prompting a tactically negative near-term view on mortgage-backed securities. Meanwhile, the housing market remains stuck in neutral, with affordability keeping activity capped but a floor of necessary transactions preventing further deterioration.

• Market expectations shifted from 2.5 Fed cuts to 1.5 hikes over the past 5.5 months, a 100bp swing.
• New Fed Chair Warsh favors shorter forward guidance, increasing uncertainty and volatility in fixed income.
• Higher volatility harms MBS because investors are short the refinancing option, and hiking expectations discourage bank/overseas demand.
• Despite strong technicals (GSE buying, low supply), Morgan Stanley is tactically negative on MBS near term.
• Housing activity remains at 40-year turnover lows, with 11 consecutive quarters of stagnant activity.
• Affordability challenges cap upside, but a base level of necessity-driven transactions keeps the current level supported.
• Overall, mortgage valuations face headwinds while housing activity is stuck in neutral.