Macro Implications Update (Fed & Labor Data)
Recent macro developments materially shift the prepayment outlook relative to the base case outlined in the August Flash. Two key updates drive this change:
• Fed Rate Cuts: High-level economists and market consensus now expect three Fed cuts before year-end (September, October, December), with the possibility of a larger 50bp move or consecutive cuts if labor weakness persists.
• Labor Market Revision: The U.S. Bureau of Labor Statistics is expected to revise payrolls down by 600k–900k jobs and monthly job growth by 50k–75k. This signals sharper cooling in the employment backdrop.
Implications for MBS prepayments:
• Lower mortgage rates are likely to arrive sooner and more decisively than assumed in the base case. This elevates CPR risk beyond a modest uptick, particularly in 5.0–6.0% coupon cohorts.
• High-coupon GNMA and conventional pools (5.5–6.0%) are now acute convexity hot-spots, with elevated refinance surge risk.
• Burnout dispersion narrows: even seasoned 2018–2020 cohorts regain prepay capacity, compressing relative differences.
• Lower-coupon 4.0–4.5% remain the defensive carry anchor, with increased relative advantage versus high-coupons.
Portfolio/Trade Framing Adjustments:
• Overweight: 4.0–4.5% conventionals and seasoned burnout pools for carry and duration stability.
• Underweight: FNMA/FHLMC and GNMA 5.5–6.0% pools, where convexity and optionality risks are most acute.
• Hedging: Expect stronger dealer short-TBA positioning in higher coupons; real-money accounts will anchor lower-coupon spreads as defensive carry.
AI Impact on Prepayment Modeling
The recent Fed and labor market developments amplify the value of the AI operator framework. Whereas traditional models would broadly shift S-curves upward in response to multiple Fed cuts, AI’s recursive operator chain and sparse attention mechanisms attribute CPR changes specifically to ΔRate shocks, avoiding overreaction in lower-coupon carry pools.
Key combined effects:
• Faster attribution: AI isolates Fed-driven rate cuts as the dominant lever, enabling earlier recognition of risk.
• Granular activation: Sparse attention ensures that only rate-sensitive cohorts (e.g., GNMA 5.5–6.0 VA streamline) are activated.
• Hedge stability: Adaptive stencils recalibrate hedge ratios locally, stabilizing convexity management even as spreads widen.
Portfolio Implication:
The macro shock strengthens the Sell bias in high-coupon pools while reinforcing 4.0–4.5 conventionals as the defensive core. AI integration makes positioning timelier, more precise, and more stable under volatile autumn conditions.
AI Macro Shock:
AI replaces a static S-curve with a recursive latent operator network. Adaptive stencils (by incentive buckets) and sparse cohort attention yield timelier, more granular buy/sell signals and steadier convexity hedges. A Recursive Latent Operator is a framework for building models that learn efficient, abstract representations of sequential data by recursively updating a hidden state using a learned function. It's a foundational concept behind most modern state-of-the-art sequence models, especially those designed for long-range dependencies, offering a powerful blend of efficiency, compression, and predictive power.
Agency MBS Prepayment Flash — Aug'25 (Sep'25 prints)
Conventional 4.0–4.5 remain the carry-defensive core (speeds ~high-single CPR); GNMA high coupons are the optionality hot-spot with MoM variance. AI lets you target exact sub-cohorts driving changes, improving both selection and hedging versus a single S-curve view.
• The portfolio strategy is to treat 4.0–4.5 conventional MBS as the anchor holdings—providing stable income and relatively resilient performance when the market swings, while other buckets (low coupons, high coupons, Ginnie Maes) are treated more tactically.
Top Takeaways
Speeds broadly in high-single to low-teens CPR; Ginnies run a touch faster than conventionals.
MoM changes small (±1–2 CPR across large cohorts); limited new refi incentive without bigger rate moves.
Seasoning & burnout dispersion: older 2018–2020 cohorts run ~1–3 CPR faster at like coupon.
GNMA high coupons (5.5–6.0) show greater variance (VA streamline/issuer effects).
Program Commentary
FNMA & FHLMC: 4.5s around 8–10 CPR across vintages, orderly behavior. 5.0–5.5s show modest uptick but no wave; turnover dominates incremental changes.
GNMA I: 5.0–5.5s run low-teens CPR with VA streamline optionality. New 6.0s show volatile prints with thin seasoning.
GNMA II: 6.0s mid/high-single CPR with MoM choppiness. Legacy 5.0–5.5s low-teens CPR with wide issuer dispersion.
Risk Themes
Fed-cut narrative vs. mortgage rates: small cut nudges CPR higher but no 2020-style wave.
Burnout: seasoned 2019–2020 cohorts more prepay-capable than newer vintages.
GNMA policy sensitivity: streamline eligibility swings CPR several points in small cohorts.
Seasonality: post-summer turnover fade should dampen CPR into autumn absent a rate shock.
Buy / Sell Framing
Buy / Overweight:
• Conventional 4.0–4.5 ('22–'23) carry-defensive.
• Seasoned burnout pools ('18–'20) for duration needs.
Sell / Underweight:
• GNMA 5.5–6.0 thin-seasoning cohorts (variance hot-spot).
• High-coupon conventionals near incentive threshold.
AI Impact on Prepayment Modeling
AI replaces a static S-curve with a recursive operator network. Adaptive stencils (by incentive buckets) and sparse cohort attention yield timelier, more granular buy/sell signals and steadier convexity hedges.
Key benefits:
Operator chain identifies which lever (ΔRate / Turnover / Credit / Policy) moved CPR.
Adaptive stencils provide local fit for incentive buckets, stabilizing hedge ratios.
Sparse cohort attention activates only relevant sub-cohorts (issuer/geo/vintage).
Generates targeted specified-pool screens and optimal TBA hedge pairs.
Source: FN/FH/GNMA flash files. Month: Aug'25 | Prepared for Sep'25 prints.
Macro Policy & Market Dynamics
Rate Cuts and Prepayment Dynamics
September Fed cut could lower mortgage rates and increase refi incentives, especially in higher-coupon pools (5.5–6.0%). “buy-the-rumor, sell-the-news” effect: if markets sell off after the cut, long-end yields may stabilize or steepen, capping refinance waves.
Equity Correction → Flight to Quality
Equity sell-off drives flows into Treasuries and MBS. Treasuries rally → mortgage rates lower → CPR rises. But MBS spreads may widen if liquidity is hit, raising convexity risk.
Buy vs Sell Trade Implications
Buy side: lower-coupon 4.5–5.0% MBS offer carry and stability; real-money accounts can anchor spreads. Sell side: higher-coupon ≥5.5% MBS face refi surge risk; dealers may short TBAs to hedge convexity.
Trade Framing
Buy: 4.0–4.5% lower-coupon, seasoned pools with limited incentive. Sell: 5.5–6.0% TBAs, where refinance exposure is most acute.
Summary: If a Fed cut combines with equity correction, prepayment risk rises. Positioning should lean to buy lower-coupon carry pools and sell/hedge higher-coupon TBAs.
This import collapse is recessionary in signal.
Likely downward pressure on rates → MBS price appreciation in near term.
Prepayment risk may rise modestly (especially in higher-coupon pools) if rates fall, but the bigger driver is spread tightening from lower rate expectations.
Buyer's Market Signs
Lower prepayment speeds make MBS cash flows more stable → better yield predictability for buyers.
Wider spreads between MBS yields and Treasuries due to policy uncertainty → buyers can lock in attractive yields.
Sellers may have to offer price concessions because fewer investors want to take on mortgage credit and duration risk in a high-rate environment.
Here's the CPR (Conditional Prepayment Rate) probability curve mapping:
Blue (Before CPI Imputation Spike): Higher prepayment expectations due to greater probability of rate cuts and refinancing activity.
Red (After Spike): Lower prepayment expectations because Fed rate cuts are less likely in the short term, keeping mortgage rates elevated.
Gray Shaded Area: The reduction in prepayment risk — this stability in cash flows benefits MBS buyers, reinforcing a buyer's market environment.
This favors a short-term BUY stance for MBS, especially in lower-coupon or new-production pools where convexity risk is lower.
