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High valuations: With holiday festivities officially underway in New York, Santa Claus visits the New York Stock Exchange. Overall US investment-grade issuance will probably top US$800bil in 2026, says JPMorgan Chase & Co. — AFP
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NEW YORK: Money managers, including Columbia Threadneedle, are looking closely at US mortgage backed securities (MBS) as a place to hide from high valuations in US corporate bonds and a wave of tech bond sales that could weigh on returns.
Overall US investment-grade issuance will probably top US$800bil in 2026, stripping out refinancings, a net increase of about 54% from this year, JPMorgan Chase & Co wrote last month.
A chunk of those sales will come from tech companies investing in artificial intelligence (AI) infrastructure.
Heavy issuance could push risk premiums slightly wider, with JPMorgan last week, estimating about 0.15 percentage point of widening for high grade US corporate debt in 2026.
“If you’re a hyper-scaler, you have so much riding on getting AI right that the additional interest expense of wider credit spreads is almost irrelevant,” said Ben Hunsaker, portfolio manager and head of structured credit at Beach Point Capital.
“The hyper-scalers are funding the data centre buildout with a mix of project finance and corporate bonds, but the path of least resistance is likely from corporate debt.”
Mortgage bonds, meanwhile, are on track to deliver their strongest returns in two decades, with the Bloomberg US Mortgage Backed Securities Index having gained 8.35% in 2025 through last Friday.
The last time the index performed better was in 2002, when it gained 8.75%.
And while corporate bond supply is on the rise, mortgage bonds will probably see only a slight increase in net supply next year, according to Morgan Stanley, in part because relatively high home prices and mortgage rates are weighing on purchase activity.
At the same time, demand for the bonds is likely to be stronger, the bank said, which can help improve performance.
Real estate investment trusts, for example, have been buying more of the bonds, as the high valuations for their stocks have helped them raise cash.
Banks will probably buy more MBS once they have more clarity about capital rule and stress test requirements for the securities, Morgan Stanley strategists, including Jay Bacow, wrote last month.
The Federal Reserve is aiming to unveil a new plan for Basel III Endgame rules as soon as the first quarter of next year, Bloomberg has reported.
And government backed mortgage companies like Fannie Mae and Freddie Mac may buy more of the securities as well, the Morgan Stanley strategists wrote.
From a valuation standpoint, mortgage bonds may not be cheap, but they are not as expensive as corporate debt.
As of last month, high grade credit was in the third percentile for valuations over the last two decades, according to Morgan Stanley, meaning they’ve rarely been more expensive than now. Mortgage bonds were in the 20th percentile.
For high grade US corporate bonds, spreads averaged about 0.8 percentage point, or 80 basis points, last Friday.
The mean over the last two decades is closer to 1.48 percentage point, according to Bloomberg.
“We have moved into MBS over time because the spreads in long investment grade have not provided the cushion for a number of risks including increased issuance or deteriorating fundamentals,” said Alex Christensen, a portfolio manager at Columbia Threadneedle Investments.
There are still risks with mortgage bonds. Investors in the securities effectively bet that uncertainty about the direction of interest rate moves, known as interest rate volatility, will decrease.
That’s been a good bet for much of the year, with a key metric of rate volatility having dropped since April.
But inflation could flare up again next year, Beach Point’s Hunsaker said, as the Federal Reserve further cuts rates.
And Japan’s plans for the biggest round of extra government spending since the pandemic could end up spreading higher longer-term bond yields to the United States as well, Hunsaker said.
Either could contribute to interest rate volatility rising.
Some investors are shifting some money out of corporate bonds and into other securitised debt.
Brian Kennedy, a portfolio manager at Loomis Sayles & Co, is looking at bonds that offer higher yields than mortgage securities, including collateralised loan obligations and bonds backed by franchise fees.
The firm is trying to minimise its exposure to interest rate risk, and in particular duration, and maximise yield, he said. — Bloomberg
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