Agency Mortgage-Backed Securities (MBS) Market

Market Commentary and Outlook | February 28, 2026

Agency MBS Maintained Stability in Volatile February
Agency MBS weathered broader risk-off sentiment better than most alternatives in February. Despite signs of economic resilience, investor anxiety over AI-driven disruption and shifting trade policies sparked a flight to quality, driving Treasury yields lower throughout the month. Domestic economic data was strong, with manufacturing surveys returning to expansionary territory for the first time since 2022, while nonfarm payrolls expanded by 130,000 and the unemployment rate declined to 4.3%, underscoring growth-supportive labor market stability. Inflationary signals, however, continued to complicate the Federal Reserve’s policy path. The headline Consumer Price Index showed signs of deceleration, but the Core Personal Consumption Expenditures Index, the Fed’s preferred inflation measure, firmed to a 3.0% rise on a year-over-year basis. Meanwhile, the Trump administration re-imposed tariffs using different mechanisms immediately after the Supreme Court invalidated those previously implemented. As a result of these upward price pressures, the expected Fed Funds rate at the end of 2026 rose despite Treasury rates falling in longer tenors. The broader macroeconomic outlook and investor focus was ultimately redefined on February 28 when the failure of bilateral nuclear negotiations culminated in joint US-Israeli military action against Iran, driving energy prices higher and ensuring that geopolitical instability will be the primary driver of financial market volatility for at least the near-term.

Through another month of broader market tumult, agency MBS performance remained relatively stable and range-bound, consistent with the market view we have espoused in prior months and we update in this issue. The Bloomberg US MBS Index gained 1.67% on the month, reflecting a -0.08% excess return to Treasuries. Sector option-adjusted spread (OAS) widened by 5bp to +21bp, though about 6bp of widening was caused by a Bloomberg prepayment model update during the month. Negative excess returns were instead driven by a rise in interest rate volatility, as evidenced by the widening in nominal spreads of 12bp on the month. This choppy performance far outpaced corporate debt, as the Bloomberg US Corporate Index widened 11bp, and the Bloomberg US High Yield Index widened 26bp in OAS.

What’s the Next Step to Lower Mortgage Rates?
The White House’s January announcement of $200 billion in buying from Fannie Mae and Freddie Mac drove mortgage rates tighter. Combined with falling Treasury rates, the primary mortgage rate hit its lowest level since 2022. However, mortgage spreads have given up some of that tightening in the weeks since, and geopolitical events and inflation concerns could push Treasury rates higher. With housing affordability still in focus ahead of the US midterm elections, what can the White House do next? We believe a likely option could be a cut in the guarantee fee that Fannie Mae and Freddie Mac charge to borrowers to insure against defaults. Based on recent public filings, the agencies have about 21bp of profitability built into the guarantee fee, constituting about 80% of their revenue. Last year, we considered a cut in the guarantee fee to be in conflict with the desire to reprivatize Fannie Mae and Freddie Mac. That process has already been endangered by the instruction to increase their portfolio sizes, threatening their autonomy and ability to prioritize profits as a publicly-traded company. If reprivatization is truly off the table due to the administration’s push to use the agencies for affordability-related goals, cutting these fees by up to 21bp is possible.

Positively, we project that most of a potential cut would pass through to the borrowers’ rate, minus a modest concession investors will demand for the increased option cost at lower rates and increased refinanceability. Alternatively, it could be targeted just to purchase loans or first-time homebuyers to reduce the impact to the agencies’ revenues.

However, as we have mentioned previously, MBS spreads vs Treasuries or primary-secondary spreads are second-order effects on mortgage rates. The primary driver is 7-to-10-year Treasury rates, which are more dependent on the market’s expectations for economic growth, inflation, term premium, and debt sustainability, and are much harder for the White House to attempt to control. Meanwhile, the housing supply shortage can be attributed to zoning laws that are broadly managed at the local (rather than federal) level, and building costs have recently been exacerbated by increased materials costs from tariffs and a decline in the homebuilding labor force from reduced immigration. In short, the White House may find it difficult to effect meaningfully lower housing costs in the near term.

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Outlook: A Range-Bound 2026, Until the Next Headline 
For the past few months, we have remained motivated to maintain a benchmark weight relative to Treasuries or a mild overweight versus interest rate swaps. Recent stability amid broader market volatility reaffirms this view. The arguments against MBS are emphatic and first-order, but offsetting positive factors provide support to the asset class at these levels.

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The balanced table above suggests a neutral allocation to most benchmarks is prudent at this time. Broadly, the willingness of asset managers to sell at tighter spreads, with banks, overseas investors, mREITs, and Fannie and Freddie willing to buy at wider spreads, can provide both the resistance and support to maintain stable spreads. We are more bullish on agency MBS as a positive contributor to an aggregate, multi-sector, or multi-asset portfolio, and we are more constructive on MBS relative to swaps than to Treasuries. Our strongest conviction lies in specified pools with characteristics we find underappreciated by the market, particularly for higher coupons with the most model risk premium, as well as in lower coupon interest-only strips. Spread compression reduces relative value overall, but we are optimistic that prepayment uncertainty and headline-induced dislocations can provide dynamic allocation and security selection opportunities.

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