Secondary marketing and origination managers should be aware of an interesting market dynamic: much of the Agency (UMBS) 30-year coupon stack is now trading with a “negative” or “inverted” roll cost. To loan originators the implication is that longer-term rate locks (later “drops”) would theoretically cost less than the short-term locks, contrary to normal market conditions.
At the time of this post, UMBS30 coupons of 3.5% and above are trading with back-month pricing that is higher than the front-month. Here’s an example for traders: the offer side of the UMBS30 4.0 Aug/Sep roll is priced at -4/32nds, which means the August offer price is 4/32nds cheaper than the bid side September price (counterintuitive to the time value of money principle).
This pricing anomaly is the result of the recent market rally, which is driving investors to discount front-month securities due to a surge in prepayments speeds on higher coupons. This is an uncommon market phenomenon that may warrant attention from secondary marketing managers to ensure that assumptions driving ratesheet pricing, mark-to-market models and/or best execution decisions are still accurate. Along those lines, here are a few areas to assess:
- Price extrapolation on long-term locks
- Ratesheet term drops
- Delivery Month Best-Ex