Peter Federico: And Trevor, just to add, you asked about the marginal buyer activity. Obviously, the key marginal buyer in this environment is going to continue to be money managers. The Silicon Valley Bank portfolios, low coupons and more than 50% of the mortgage index is made up of these low coupons. So, the money managers are going to be the key buyers of mortgages going forward at the margin. I think large banks could, at some point, come back into the market. But more importantly, I think there’s going to continue to be a rotation out of treasuries into Agency mortgage-backed securities. And I think we started to see some of that over the last several months. I think there’s demand on an absolute unlevered basis for Agency MBS that is growing.
I think you see that in the formation of the ETFs that have occurred. BlackRock ETF has gained a lot of asset value over the last six months. DoubleLine initiated an agency ETF. So, I think there’s going to be demand that will continue to — fixed income demand that will continue to make its way into the Agency MBS market, but it’s just going to take time, but I think that sets up for a positive dynamic.
Trevor Cranston: Yeah, that makes sense. Okay. Thank you, guys.
Peter Federico: Thank you, Trevor.
Operator: And our next question will come from Doug Harter with Credit Suisse. Please go ahead with your question.
Doug Harter: Thanks. In your prepared remarks, you mentioned kind of favorable funding markets. Can you just talk about how you’re thinking about the debt ceiling and kind of how you’re seeing funding markets kind of around that time?
Peter Federico: Sure. Thanks for the question, Doug. Good morning. We really haven’t seen any disruptions in the Agency funding market. And that’s one of the things that obviously makes Agency MBS so compelling on a relative value basis. Chris mentioned that in his prepared remarks that spreads are materially wider and the funding is still uniquely positive for Agency MBS. So that’s a really positive long-term factor for us. Looking back at the first quarter, there was really very little disruption in the Agency mortgage market. There’s still a lot of liquidity. I don’t expect the debt ceiling to have any impact on the repo market for Agency MBS or for U.S. treasuries for that matter. The amount of money in the money markets system, the amount of money at the reverse repo facility at the Fed sort of signals to me that there’s plenty of liquidity in the funding markets.
I don’t expect that the debt ceiling to be an issue in the repo markets. It may be an issue in interest rate volatility with respect to treasuries, but that’s one of the reasons why we’re operating with a relatively small duration gap. We’ll continue to keep our interest rate exposure low. And ultimately this debt ceiling issue will get resolved. I think the market is mature enough and has gone through this enough times to know that a solution will be found. Hopefully, it can be found quick. But if it’s not, I think the market ultimately will price in the fact that it will be resolved.
Doug Harter: Great. Thank you.
Peter Federico: Sure. Thanks for the question.
Operator: And our next question will come from Bose George with KBW. Please go ahead with your question.
Bose George: Hey guys, good morning.
Peter Federico: Good morning, Bose.
Bose George: Peter, in your comments, you noted a new trading range in Agency MBS. Can you talk a little more about that sort of into just in terms of nominal spreads where you think things could end up?
Peter Federico: Sure. Well, what’s interesting, Bose, when you — at this point when you look at Agency MBS spreads, a lot of times it’s — it really is dependent on where you look sort of at a point on the curve because you can have meaningful differences whether you use treasuries or swap hedges or whether you use 10-year hedges or 3-year hedges. But when you look at mortgages today, Agency MBS, they’re cheap by all measures. For example, if you look at 10-years to 3-years in the treasury market, the spreads are somewhere between 125 basis points and 175 basis points. If you look at it, mortgages against SOFR market 3-years to 10-years, they’re 150 basis points to 200 basis points. So that’s why I think everybody looks at the mortgage market and said, they’re probably in the 160 basis points to 175 basis point range.
Ultimately, I think spreads will tighten from here. I think they can trade in this 150-ish basis points range for some period of time. And the reason why I sort of come to that number is that I think that’s a number that is obviously about double, if you think about that versus the 10-year, that’s about double the spreads that we’ve experienced for the last 10 years. So that’s meaningfully wider, but that’s a lot of additional compensation for the same credit quality as the U.S. treasury. So, think about it, if you’re looking at the 10-year treasury at 3.5% and you can earn 5.25% for the same credit quality for a duration that’s actually shorter than a 10 year, I think that’s really compelling. I think investors in this environment requires a higher return.
It’s not surprising that we are here given the amount of monetary policy uncertainty and economic policy uncertainty. I think the market is going to be highly sensitive to economic data for the next several months until it’s clear how the Fed is going to progress through this pause period. So, I think it keeps spreads in this range. But if you ask me 12 months from now where are spreads, I would say they’re tighter than they are today, but they’re still wider than — meaningfully wider than historical averages.
Bose George: Okay, great. Thanks. That makes sense. And then…
Peter Federico: Sure. Bose, I mean, I think that’s just — yeah, I just think that’s really the key point and the message is that, that really does set up for a very good earnings environment. So, I’m sorry, go ahead.
Bose George: Yeah, no, absolutely. That makes sense. Thanks. The other question I had, and I think you guys referred to this briefly, but what was the driver of the treasury — long treasury position that you put on end of the quarter?
Peter Federico: Yeah. Well, that really gets back to repositioning from a yield curve perspective our hedges. During the quarter, obviously, things started to move very quickly, so we wanted to achieve two things during the quarter. We wanted to maintain a positive duration gap given the rally that was occurring late in the quarter. So, we rebalanced by adding duration and allowing us to benefit from a rally that was occurring to give us more protection against the spread widening — mortgage spread widening in a rally environment and we were able to do that. And at the same time, we wanted to continue to reduce our shorter-term hedges — from there, I’d say, 5-years and in, intermediate to short-term hedges and maintain our longer-term hedges.
So to achieve that objective — both of those objectives, we ended up actually buying 5-year treasuries while maintaining our short position in 10-year treasuries, thus giving us a yield curve exposure to the curve steepening. So, it was consistent with that move. Over time, we’ll continue to adjust our aggregate hedge position, but that was the idea behind that.
Bose George: Okay, great. Thanks a lot.
