Uncovering Opportunity Amidst Rates Repricing

• Interest rate markets currently price one 25 basis point Fed cut through January 2027, but the MOVE Index shows rising implied volatility, reflecting increased uncertainty around inflation and policy responses
• Agency MBS yields have risen alongside Iran-driven rate volatility, underperforming after a strong rally in late 2025, following the typical pattern during periods of negative convexity pressure
• The MBS cheapening is viewed as an opportunity rather than a trend shift, as shelter inflation continues declining and labor market softness supports the case for Fed rate stability or modest cuts

Summary: Uncovering Opportunity Amidst Rates Repricing

Key Event: US/Iran conflict disrupted global markets, causing energy market upheaval and interest rate repricing. Concerns over prolonged hostilities and potential Strait of Hormuz closure shifted market dynamics.

Market Context: Pre-conflict conditions were considered "goldilocks" – moderate economic expansion, declining inflation, and anticipated Fed rate cuts. The oil shock introduced the possibility of rate hikes into market pricing, expanding the range of potential outcomes.

Interest Rate Outlook:

• Markets still price one 25 basis point Fed cut through January 2027
• Rate volatility increased significantly
• The MOVE Index (interest rate volatility tracker) rose in recent weeks, signaling renewed uncertainty

MBS Market Impact:

• Agency mortgage-backed securities (MBS) experienced pressure due to rising rate volatility
• MBS yields increased alongside Iran-driven uncertainty
• Negative convexity from prepayment options makes MBS vulnerable during volatile periods
• Recent MBS weakness follows strong outperformance in late 2025

Investment Opportunity: Sage Advisory views the MBS cheapening as a buying opportunity rather than a trend reversal, citing:

• Constrained inflation impact from oil shock
• Shelter's greater weight in inflation basket continues declining
• Persistent downside growth risks
• Labor market softness and credit concerns support Fed maintaining accommodative stance

Conclusion: While geopolitical tensions created market volatility, fundamental economic conditions—including declining shelter costs and labor market weakness—suggest the Fed will likely stay on hold or continue modest rate cuts, creating active positioning opportunities in fixed income markets.