Primarily invests in Government National Mortgage Association (GNMA) securities with maturities in excess of one year and which have the same credit quality as U.S. Treasury securities, but higher yields to compensate for prepayment uncertainty.
- The U.S. Federal Reserve is near the end of its interest rate hike cycle, raising short-term interest rates by only 0.25% in the quarter. The Fed is reducing its balance sheet through runoff, with 3Q23 runoff equating to around $55 billion.
- Interest rates significantly sold off with the 2 year/10 year steepening 58 basis points (bp) during the third quarter. Additionally, the 30-year fixed mortgage rate increased approximately 55 bp to 7.36%. At these levels, around 99% of the mortgage-backed securities (MBS) Index has lost its economic incentive to refinance.
- MBS underperformed as they have been trading directionally with rates recently. Rising rate volatility was also a significant contributor to the underperformance. Belly coupons (e.g., 3s to 4s) lagged the wings.
- Underperformance throughout the MBS Index is reflected in the mortgage spreads widening across the Index for both zero-volatility and option adjusted metrics. MBS spreads are now near the widest level in years.
- Housing markets remained resilient through the period with stable prices despite rising mortgage rates. Both new home sales and existing home sales have decreased with existing home sales decreasing at a greater rate.
- For the quarter, the Voya GNMA Income Fund outperformed its benchmark, the Bloomberg GNMA Index, on a net asset value (NAV) basis.
Current Strategy and Outlook
Agency MBS struggled to catch a bid in the third quarter as rates sold off and rate volatility jumped towards the end of September. Going forward, Federal Deposit Insurance Corporation (FDIC) auctions are in the rearview mirror as they have concluded their mortgage pool sales and only have a small amount of collateralized mortgage obligations (CMO) remaining (around $2.8 billion). This, along with a slowing housing market, would provide a tailwind on the supply side to the agency MBS market. Inflation has rebounded by some extent over the quarter with headline Consumer Price Index (CPI) increasing modestly. Additionally, a strong labor market and consistently higher-than-expected monthly job gains suggests the Fed may have to maintain a restrictive stance for longer than many anticipate. The expected lower MBS supply and fears of a potential recession should benefit MBS demand as a flight-to-safety entices money managers to increase allocations. Additionally, if new banking regulations require smaller banks to follow similar regulatory requirements akin to their larger, global systemically important bank (GSIB) counterparts, we could see resurgent bank demand for Ginnie Mae MBS.
Housing prices remained stable during the summer with Case-Shiller 20-City Home Price Index up a seasonally adjusted 0.87% in July. This is partly due to limited housing inventory caused in part by the strong lock-in effect. Overall MBS supply is expected to be relatively light for the foreseeable future; however, we will continue to monitor the technical factors impacting MBS supply.
The Voya GNMA Income Fund maintains an allocation to conventionals (Federal National Mortgage Association and Federal Home Loan Mortgage Corp.) citing attractive relative value, as well as CMOs which offer greater longer-term value with higher spreads relative to generic collateral, especially on an option-adjusted basis. Additionally, the Fund maintains a preference for higher coupon collateral versus the deep discounts where nominal spreads remain tight.
For the quarter, the Fund outperformed its benchmark. Outperformance was mostly attributable to a shorter duration as well as off-benchmark CMOs including floaters. Meanwhile, our overweight to the belly coupons detracted slightly