Smriti Popenoe: Yes, yes, I mean that’s interesting. So let me give you some fundamental observations about the mortgage market here. The Fed is basically coming out and telling us that they’re pretty much done raising rates. Now the argument is, are they going to raise in November or December? Either way, you’re looking at maybe one more hike and then they’re going to stop for some time. So this limits how much front-end rates can rise from here, alright? So you now have the front-end a little bit pegged. The second thing is the biggest bank selling that we had, you know, this year is done right? Now there might be some shadow banking, bank stuff, you know, bank supply stuff out there but by and large the active selling is over, okay?
The third thing that’s happened here at this which is really important is the yield curve is substantially steeper and for the first time now you actually have agency mortgage yields at a positive yield spread versus Fed funds. So the yield on current coupon mortgages is around 6.5%, 7%. Fed funds is at 5.5%, that’s a lot of carry in mortgages. It’s very positive in terms of just sitting here and keeping on owning the asset, right? Another point, the net supply picture for the first time is actually starting to look positive. The Fed’s runoff from their balance sheet is going to shrink from, let’s say, $15 billion to $20 billion a month. It’s going to go down to maybe $13 billion to $15 billion, so there’s a few less mortgages that the market is going to need to absorb from the Fed.
And with mortgage rates around 8%, supply is really going to start to taper off here, especially in the winter, right? And then the last piece of this is that you are starting to see credit trends deteriorate, right? There’s headlines about auto loan delinquencies rising, corporate bond delinquencies rising, percentage of bonds that could be downgraded rising, all of those things eventually, right, make it, make your money good asset worth more. So in general, right, is that 200 basis points, upper end of the range, you know, intact, solid. I can’t say that to you. I can say that there are many factors in play today that really limit how much further that those spreads can go. Now, because we’re cognizant of the technical picture, we’re prepared for whatever, you know, for it to blow out past that.
But in general, there are many things we see in place right now that say, okay, look, even if we get out there, there’s a reasonable thought process around why you could quickly come back to more tighter levels of spread from those extremely wide levels.
Trevor Cranston: Yes. Okay, that makes sense. Thank you.
Smriti Popenoe: Sure.
Operator: Your next question comes from a line of Matthew Erdner from Jones Trading. Your line is open.
Matthew Erdner: Hey good morning guys. Smriti, congrats on the board nomination and thanks for taking the questions. So you mentioned the spread range and I’m going to kind of follow-up on the question before. What do you think drives them tighter? Is it other people getting in the market to, kind of, absorb some of the supply and stop the technical selling? Or is it the Fed, kind of, hinting that they’re going to start to cut rates? Or just, kind of, figure out the duration of how long that they will hold?
Smriti Popenoe: I think it’s all of those things, Matthew, and I appreciate the congrats. Thank you for that. Look, I wish, I could say, hey, these are there — these are — if this happens, they’re going tighter, right? One of the things that’s happened right now is that you’ve got a technical situation where money managers have become net sellers. One thing that keeps me, sort of, like very disciplined about my view on mortgage spreads is what happened to mortgages in January of this year. This year, once retail and RIAs and basically, the investor universe decided that it was going to be the year of the bond, mortgage spreads tightened to like 120 bps. That’s a very positive outcome when you go back and see what happened to mortgage spreads this year, okay?
