Portfolio Managers John Kerschner, Global Head of Securitized Products & Portfolio Manager, pictured, and Nick Childs discuss the reasons for their bullish view on MBS in 2026.
2025 turned out to be a year for the ages for agency mortgage-backed securities (MBS), as the Bloomberg U.S. MBS Index registered its best calendar year of returns since 2002. The benchmark index’s 8.58 per cent total return outperformed every major fixed income sector other than high yield (+8.62 per cent) in 2025.
On an excess return basis, MBS generated 171 basis points (bps) in excess return over U.S. Treasuries.
Several factors contributed to the performance, including a steeper yield curve, wide risk-adjusted spreads to start the year, falling rate volatility, and constructive supply/demand technicals. The back half of 2025 also saw a noticeable uptick in MBS purchases from banks and government-sponsored enterprises (GSE), which helped drive spreads lower.
Given 2025’s impressive performance, investors may be asking what is in store for 2026. In our view, 2026 is poised for another year of strong performance, with many of the same tailwinds in place that supported returns last year.
Key factors that may drive MBS returns in 2026
Lower rate volatility
Interest rate volatility typically has a significant impact on MBS spreads. As rate volatility increases, the value of a mortgage holder’s embedded refinancing option also increases, negatively impacting MBS spreads. The inverse also holds true, though: Lower rate volatility results in tighter MBS spreads, all else equal.
When the Federal Reserve (Fed) started raising interest rates in 2022, rate volatility spiked and remained elevated through mid-2025 amid stubborn inflation and uncertainty regarding monetary policy. Once it became clear during the second half of 2025 that the Fed had room to cut rates as inflation risks softened, and rate volatility fell sharply.
With inflation continuing to ease and the Fed maintaining a more dovish stance, we think lower rate volatility is likely to persist in 2026.
A steeper yield curve
A steeper yield curve is generally constructive for MBS returns because it improves both the carry, or income, profile and convexity dynamics of the asset class. The recent re-steepening of the yield curve contributed to returns for MBS in 2025.
We expect the curve to remain steep – and perhaps steepen further – as short-term rates continue their downward trend and term premiums persist due to concerns surrounding Fed independence, large and continued fiscal deficit spending, and potential delayed tariff effects. Higher term premiums also typically lead to more stable prepayment speeds and reduce the risk of a refinancing wave.
3. Demand for MBS
A significant contributor to recent spread tightening has been increased buying from banks and the GSEs. The GSEs will be active buyers again in 2026 due to the Trump administration’s announcement of USD200 billion in MBS purchases to bring down mortgage rates. We also expect an increasing presence from domestic banks.
A steeper yield curve should also attract incremental demand from real estate investment trusts (REITs), as it implies cheap short-term funding and higher asset yields further out on the curve. Lastly, we expect demand from money managers to persist, as positive flows into duration assets may continue their current trajectory.
Until recently, bank demand for MBS has been somewhat tepid relative to expectations. One of the reasons for this has been sluggish deposit growth as higher short-term rates provided better alternatives for depositors. However, short-term rates are being pressured lower by Fed policy, recently announced reserve management purchase operations (USD40 billion per month flowing into Treasury bills), and stablecoin legislation enacted last summer.
These developments are positive for deposit growth and net interest margins, which may support increasing MBS demand from banks. Additionally, Federal Reserve Vice Chair for Supervision Michelle Bowman has indicated a softer, more industry-friendly Basel III endgame proposal for early 2026 that implicitly includes room for relief on securitisation capital. We view the decision as a net positive that could further boost demand for MBS.
4. Relative value opportunities
Although MBS spreads narrowed in 2025, we believe they remain attractive relative to investment-grade (IG) corporate credit. Furthermore, we expect net IG corporate supply to increase significantly in 2026, largely driven by artificial intelligence (AI) infrastructure funding needs.
While MBS net supply should be similar to 2025, increased demand from banks and a large “new” buyer in the GSEs materially helps the supply-demand picture, which should be constructive for MBS spreads versus IG corporates.
In summary
In our view, mortgages offer attractive carry per unit of credit, convexity, and liquidity risk. We think fundamentals and technicals are aligning to provide a favourable environment in 2026, while the relative value of agency MBS remains attractive compared to IG corporate credit.
The asset class has historically rewarded nuanced security selection and active convexity management, making it, in our view, a compelling fit for active managers.
