QT-nearing-end: Agency MBS Update

QT (Quantitative Tightening) = shrinking the balance sheet mostly by runoff (letting Treasuries/MBS mature or prepay without reinvestment). Active MBS sales would be a separate, explicit policy step. The Fed has not been selling MBS in this cycle; its long-run plan is to migrate toward Treasuries primarily via runoff, not by dumping MBS. MBS market read-through: Ending QT (with no sales) removes a supply headwind → generally basis-friendly (tighter spreads), all else equal. Based on the Recursive Cognitive Lattice (RCL) framework and known dynamics in the Agency MBS space, here’s how the “QT-nearing-end” regime shift might drive buy vs. sell pricing (i.e. where MBS valuations get bid or offered) across different segments and risk profiles. (These are directional views and depend heavily on market micro structure, yield curve moves, and convexity effects.) Key levers for MBS pricing Before diving into directional bias, it helps to restate what drives the pricing spread (and thus buy/sell levels) for agency MBS: 1.Treasury / benchmark yield moves: MBS yields must compete with Treasuries; when Treasury yields fall, MBS yields and spreads adjust. 2.Option-adjusted spread (OAS) / basis spread vs Treasuries: compensation for prepayment, liquidity, and financing risk. 3.Convexity / negative convexity risk: MBS suffers from negative convexity (prepayment accelerates when rates drop) and hedging costs. 4.Supply / demand flows: Fed behavior, bank / dealer / investor activity, and deposit dynamics. 5.Credit / guarantee / agency “risk premium”: For agency MBS, credit risk is minimal, but perception and liquidity premium still matter. 6.Volatility / risk premiums: In stressed regimes, spread widening (sell side) dominates; in stable regimes, tightening can dominate. How the shift tilts MBS toward better “buy side” levels (i.e. sellers will have to offer tighter spreads / higher prices) Here’s how the regime shift favors more constructive MBS pricing:

So overall, the regime shift should move pricing toward tighter spreads / higher price levels (i.e. more favorable to buyers but tougher for sellers) — especially in the higher-coupon / more liquid tranches. Where downside / sell pressures might still bite (i.e. caveats on how far buy side can demand) However, the move is not uniformly one way. There remain tail risks or structural constraints that may prevent spreads from collapsing or prevent sellers from paying up too much. Here are the constraints: • Treasury yield volatility / rate shocks: If yields jump (say from surprise inflation or hawkish surprise), MBS will reprice sharply downward (spreads widen). Sellers will demand “protection” via wider pricing. • Prepayment / extension risk: If rates fall, prepayments accelerate, shortening durations. Buyers demand spread compensation for this. • Residual supply from issuance / mortgage refinance / credit stress: Even if Fed stops selling, new issuance or refinancing flows can compete with existing MBS holders. • Dealer inventory / capital / balance sheet constraints: In stressed periods, dealers may widen bid-ask to protect themselves. • Liquidity premium floor: There is a base level of spread that compensates for liquidity risk, especially in less liquid / off-the-run MBS or structured tranches. Hence, while the regime shift favors tighter spreads, markets will still likely maintain a buffer for risk. Directional pricing views: Buy vs Sell levels Putting the above together, here’s a sketch of how buy vs sell quotes (bid/offer spreads) might evolve: • Current coupon (CC) MBS: These might see the tightest compression. If spreads are, say, 120–140 bps over comparable Treasuries currently, buyers might push that toward 100–120 bps if the regime persists. (This is hypothetical, but many strategists believe MBS spreads have room to tighten. Rest of the world+3viewpoint.bnpparibas-am.com+3PIMCO+3) • Premium / high coupon MBS (e.g. 5.5 %, 6 %): These may tighten relatively more (due to better cash flows). The buy side could bid aggressively, especially for tranches with better convexity profiles. • Off-the-run or less liquid MBS / structured MBS: These will continue to demand a liquidity premium. Their bid/offer spreads might see modest compression, but likely not as dramatic as CC. • Widening of bid/offer spreads in stressed windows: Even in this regime, near FOMC, CPI prints, or macro surprises, sellers may widen ask levels temporarily to reflect uncertainty. • “Bid shading” by sellers: Sellers might be reluctant to cut their ask aggressively, keeping a buffer in offers in case the regime reverts (i.e. they leave room for adverse surprises). Thus, in practice, you might see bid levels (buy side willingness) move up more aggressively than ask levels move down. So mid-spread compression will be gradual, and much depends on flows and confidence in regime stability. Practical recommendations (buy vs sell pricing) • Aggressively lean to the buy side in stable windows: When volatility is calm and Treasury curves behave, push for tighter spreads. • Use layered entries: Don’t try to capture full compression in one shot — scale in across several levels. • Set stop / exit thresholds: If yields jump or spread widen beyond certain triggers, exit or hedge. • Favor CC / high-coupon, liquid MBS over off-the-run or esoteric tranches — the compression potential is higher and liquidity is safer. • Watch treasury moves tightly: Because MBS repricing is tied to Treasury moves, sudden yield jumps will force quick repricing decisions. • Use hedges / convexity controls: Have hedges pre-positioned to protect downside (payer swaptions, etc.) so you can bid more aggressively without catastrophic tail risk exposure. Bottom line In a regime where the Fed is signaling the end of balance sheet runoffs and liquidity risk is easing, agency MBS pricing should gradually tilt more favorable to buyers (i.e. tighter spreads, higher price levels) — especially in the most liquid buckets. Sellers will increasingly have to offer more attractive pricing to entice buyers, though they will still protect themselves through buffers and spread floors, particularly in riskier or less liquid segments.

Buy/Sell Heatmap

For example: • "↓ Beta" under US Equities = the RCL lattice sees rising systemic uncertainty → reduce market beta (trim index exposure). • "↑ Duration" under US Treasuries = recursion favors duration as a counter-cyclical hedge. • "↑ Weight" under MBS 6.0–7.5 % = RCL suggests overweighting those coupons because lower yields improve convexity returns.

Yield Curve Downshift → MBS Relative Value Impact

1. Macro Yield Curve Overview The U.S. Treasury yield curve has shifted downward and remains inverted. This suggests a pre-recessionary phase with expected Federal Reserve rate cuts. Lower yields indicate easing financial conditions, weaker growth outlook, and a transition from tightening to an accommodative cycle. 2. MBS Pricing Implications A downward yield curve impacts MBS pricing through refinancing incentives, carry dynamics, and OAS behavior across coupons: - Low-coupon MBS (1.5–3.0%) face accelerated prepayments as mortgage rates decline, reducing duration and richening valuations — reinforcing SELL signals. - Mid-coupon MBS (3.5–5.0%) show mixed behavior; carry remains positive, but refi risk rises. - High-coupon MBS (6.0–7.5%) benefit from limited prepayment exposure and stable carry, supporting BUY signals. 3. Updated Buy/Sell Heatmap

4. Strategy Implications Portfolio positioning should shift up in coupon, emphasizing carry-rich and duration-stable sectors. Key tactical views include: • Overweight 6.0–7.5% FNMA/UMBS TBAs • Underweight 1.5–3.0% low-coupon pools • Rebalance 4.0–5.0% as curve steepens • Consider receiving swaps to hedge duration in lower coupons 5. Summary The downward-shifting yield curve implies imminent monetary easing. MBS relative value shifts toward higher coupons with resilient carry and convexity. Low coupons are vulnerable to renewed refinancing waves, warranting underweight exposure.

September Agency MBS Commentary Report

1. Overview This report analyzes the September 2025 Agency MBS prepayment data derived from FNMA, FHLMC, and GNMA flash reports. Using the DeepSeek MoE R1 RCL DSA MLA AI_v3 framework, a 3,000-path Monte Carlo simulation was run to model S-Curve prepayment dynamics, effective duration, convexity, and relative value across the coupon stack. 2. Methodology The model applies an incentive-driven S-Curve CPR function where prepayments accelerate as the primary mortgage rate falls below the weighted-average coupon (WAC). The 10-year Treasury rate was modeled as a mean-reverting process (OU), with a 1.0% monthly volatility and 0.18 mean reversion coefficient. Each coupon’s prepayment behavior was simulated over 3,000 random paths, computing discounted cashflows to obtain fair value under a 50 bps base OAS assumption. 3. Model Results

Table 1. Modeled FN30 Buy/Sell signals based on OAS-to-Par Monte Carlo outputs.

4. Interpretation & Insights Coupons with higher OAS-to-Par values are modeled as cheaper relative to the cross-sectional mean, hence marked as 'Buy'. Conversely, those with lower OAS-to-Par appear rich and are flagged as 'Sell'. The effective duration and convexity figures reflect path-dependent risk sensitivities. This model can be enhanced by integrating the live TBA screen prices and actual forward curve data for more precise relative value assessment.