It’s not all bad news. 

While rising rates may cause duration extension headaches for mortgage-backed security investors, premium coupons’ relative performance may be helped by slowing prepayment speeds. Production coupons, too, may see a boost due to less supply as home sales slow.

The 30-year mortgage rate has risen to 4.64 percent, its highest since January 2014. This has removed most of the outstanding universe of borrowers from having any incentive to refinance their mortgage and, coupled with rising home prices and new tax laws, has pushed some home buyers to the sidelines. 

The greatest beneficiary from lower supply and muted prepayment speeds will likely be current production mortgage-backed securities as well as premium coupon mortgages higher in the coupon stack.

• "At today’s mortgage rates, 4s are becoming the production coupon" and "4.5s will become nearly a third of issuance" later this year, JPMorgan’s MBS strategist team led by Matthew Jozoff wrote in a Feb. 23 research note

With net supply forecasts being "dialed back a little bit" -- and holding other factors steady -- lower issuance will "certainly help the current coupon" from a technical standpoint, according to Wells Fargo managing director on the mortgage trading desk Kevin Jackson.

• BofAML MBS strategists forecast net supply of $238b this year, assuming a 3.5 percent decline in existing home sales and a 2.50 percent 10-year yield. At a 2.75 percent yield that drops to $220b
  • 10-year yield currently 2.86 percent
• Nomura’s MBS strategist team has reduced its net supply forecast to $275b-$305b at a 4.50% 30-year mortgage rate from it’s previous forecast of $305b-$335b published in their 2018 outlook
  • 30-year mortgage currently 4.64 percent

From a historic perspective, the last time mortgage rates surged, from September 30, 2016 to December 31, 2016, the 30-year rate moved to 4.45 percent from 3.62 percent. Over that three-month span the U.S. 30-Year MBS Index saw excess returns of 21 and 19 basis points, respectively, against U.S. Treasuries and swaps, according to BofAML indexes.

Tax reform certainly isn’t helping home sales either, as the inability to deduct property taxes above a $10,000 threshold will likely work to move housing prices in the more expensive areas to a new, lower clearing level, also helping to reduce mortgage supply.