Earnings Call Transcript - AGNC Q3 2021

Operator, Operator

Good morning everyone, and welcome to the AGNC Investment Corp. Third Quarter 2021 Shareholder Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please also note today's event is being recorded. At this time, I would like to turn the conference call over to Katie Wisecarver in Investor Relations. Ma'am, please go ahead.

Katie Wisecarver, Investor Relations

Thank you all for joining AGNC Investment Corp Third Quarter 2021 Earnings Call. Before we begin, I'd like to review the Safe Harbor statement. This conference call and corresponding slide presentation contains statements that to the extent they're not recitations of historical fact, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such forward-looking statements are intended to be subject to the Safe Harbor protection provided by the Reform Act. Actual outcomes and results could differ materially from those forecast due to the impact of many factors beyond the control of AGNC. All forward-looking statements included in this presentation are made only as of the date of this presentation and are subject to change without notice. Certain factors that could cause actual results to differ materially from those contained in the forward-looking statements are included in the Risk Factors section of AGNC's periodic reports filed with the Securities and Exchange Commission. Copies are available on the SEC's website at sec.gov. We disclaim any obligation to update our forward-looking statements unless required by law. Participants on the call include Peter Federico, Director, President and Chief Executive Officer. Bernie Bell, Senior Vice President and Chief Financial Officer. Chris Kuehl, Executive Vice President and Chief Investment Officer. Aaron Pas, Senior Vice President of Non-Agency Portfolio Management, and Gary Kain, Executive Chair. With that, I'll turn the call over to Peter Federico.

Peter Federico, CEO

Thanks Katie, and thank you to everyone on the call today. We are very pleased with our third quarter financial results. Economic return for the quarter totaled 2.3%, while net spread and dollar roll income came in at $0.75 per share in line with the previous three quarters. Our economic return for the year is now 4.7%, which I believe speaks to the strength of our business model given considerable interest rate volatility, elevated prepayment speeds, spread widening, and the Fed's progression toward asset tapering. The message that we communicated last quarter was one of cautious optimism and a desire to maintain portfolio flexibility. We identified several risks that shaped the agency investment landscape, including uncertainty with respect to the timing and duration of Fed tapering, two-way interest rate risk, and elevated prepayment speeds. In the third quarter, there were positive developments regarding each of these risks. With respect to asset tapering, the Fed's anticipated timeline is now known, and market expectations are well aligned. The most likely scenario is that the Fed will announce tapering at the November meeting, commence tapering in December and reduce MBS purchases by $5 billion per month over an 8-month period. Under this approach, the Fed will purchase close to $200 billion of agency MBS between now and July of next year. Once tapering is complete, and this is a very important point, the Fed will continue to buy billions of dollars of agency MBS on a monthly basis as they reinvest the paydowns on their existing portfolio. The Fed's reinvestment program will likely continue for a significant period of time and should be a positive technical for agency MBS. The interest rate and prepayment environment also improved in the third quarter, with intermediate and longer-term rates increasing late in the quarter. Primary mortgage rates are now about 40 basis points above the February low of 2.8%. This increase in rates should lead to a more benign prepayment environment and lower supply. Taken together, greater clarity from the Fed, higher interest rates, and slowing prepayment speeds create a more favorable backdrop for agency MBS, particularly given the spread widening that has already occurred. And while some spread volatility is possible during the tapering cycle, we do not expect significant widening as agency MBS already look attractive relative to other financial assets which still trade at or near historically tight levels. Projected returns on new investments were relatively unchanged during the quarter. Lower coupon TABs continue to offer the most attractive return at around 12%, including the additional benefit from favorable dollar roll funding. Returns on higher coupon MBS, meanwhile, remain in the high single-digit range. Spreads on most non-agency securities remain historically tight, keeping expected returns on these investments in the mid-single-digit range. As such, levered positions in agency MBS continued to look compelling on both an absolute and relative basis. While the outlook for agency MBS has improved relative to last quarter, there is still considerable uncertainty with respect to the broader economic and interest rate environment. Most notably, inflation measures are elevated, and supply chain shortages and disruptions appear to be intensifying and more widespread. At the same time, the employment outlook appears to be poised for strong growth in the coming months as job vacancies outpace job seekers, unemployment benefits return to normal levels, and wages increase. As a result, the Fed's transitory inflation narrative could become increasingly difficult to defend. If inflation pressures persist or intensify further, there is a risk that the market and the Fed lose confidence in this view. In this scenario, expectations with respect to Fed actions could become increasingly difficult to predict. Given this macroeconomic uncertainty, we continue to favor operating with a more conservative risk profile. Looking ahead, we believe we are very well-positioned for the current environment with a well-balanced asset portfolio, significant hedge protection, and leverage at around 7.5 times. Together, this position gives us considerable flexibility to take advantage of attractive investment opportunities as they arise. With that, I'll now turn the call over to Bernie to discuss our financial results in greater detail.

Bernie Bell, CFO

Thank you, Peter. AGNC had total comprehensive income of $0.37 per share for the quarter. Economic return on tangible common equity was 2.3%, comprised of the $0.02 increase in our tangible net book value and 9% annualized dividend yield for the quarter. So far for October, we estimate our tangible net book value is up marginally. Consistent with our decision to operate with lower risk in the current environment, our at-risk leverage declined to 7.5 times our tangible equity as of September 30th. Notably, despite our smaller asset base, net spread and dollar roll income remain very strong at $0.75 per share. We attribute this positive performance to a very strong funding environment, stable hedge cost, and favorable TBA dollar roll opportunities, which drove a 10 basis point increase in our net interest spread to 2.19% for the quarter. Our forecasted life CPRs decreased to 10.7% as of quarter-end, due to changes in portfolio composition and higher interest rates. Our actual prepayment rate for the quarter also trended lower at 22.5%, compared to 25.7% for the prior quarter. Our most recent prepayment rate published this month for assets held as of September 30th, decreased to a post-pandemic ROE of 19.8 CPR. Lastly, our unencumbered cash and agency MBS at quarter-end increased to $5.2 billion, which excludes unencumbered credit assets and assets held at our captive broker-dealer subsidiary. Importantly, as Peter noted, our strong liquidity position at 51% of tangible equity gives us considerable flexibility to opportunistically increase leverage. With that, I'll now turn the call over to Chris to discuss the agency mortgage market.

Chris Kuehl, CIO

Thanks, Bernie. During the third quarter, the economy continued to make progress and the Fed did a good job setting the stage for an official announcement at the upcoming November meeting that it will soon begin to slow the pace of balance sheet growth. Importantly, the solidification of the timeline for tapering was achieved without market disruption, in sharp contrast to what happened in 2013. Interest rates were modestly higher with 5-year and 10-year swap rates increasing 8 and 7 basis points respectively. However, there was significant intra-quarter volatility with the Delta variant concerns driving 10-year yields down to 117 basis points in early August before selling off to end the quarter at nearly 1.5%. Fixed income spreads were relatively stable quarter-over-quarter with credit remaining near historical highs. Within the agency MBS sector, higher coupons outperformed as interest rates drifted higher, and actual speeds continued to show signs of prepayment burnout. Over the near term, the prepayment backdrop will likely continue to benefit from slowing seasonal factors and the move higher in rates since quarter-end. Lower coupon MBS modestly underperformed hedges as the Fed prepared the markets for tapering. It's anticipated that the Fed will deliver the official tapering announcement next week, and to reiterate, we do not expect a repeat of the taper tantrum or spreads widening materially. The funding markets for agency MBS remain incredibly deep and liquid, prepayment risk is trending lower, and cross-sector relative valuations continue to be supportive of agency MBS. And so while we do anticipate an increase in volatility with an active Fed, spread widening events will likely be shallow and provide us with an opportunity to increase leverage. As of quarter end, our investment portfolio totaled just over $84 billion, down $3 billion from the prior quarter, and our asset composition was largely unchanged. With interest rates modestly higher quarter-over-quarter, our hedge portfolio was also relatively unchanged at $73 billion covered 98% of our funding liabilities. The current portfolio now totals $13 billion and provides significant protection in the event that longer-term interest rates move meaningfully above 2%. Our duration gap at quarter-end was 0.4 years, little change from the prior quarter. In the current environment, we continue to favor a slightly positive duration gap given that we expect agency MBS to trade to relatively short durations, likely underperforming on a rally scenario and outperforming in most higher rates scenarios. I'll now turn the call over to Aaron to discuss the non-agency markets.

Aaron Pas, SVP of Non-Agency Portfolio Management

Thanks, Chris. I'll quickly recap the quarter and provide a brief update on our current positioning. As Chris mentioned, credit spreads were mixed during the quarter and remain near post great financial crisis tights. At current spread levels, we would expect that future returns will be generated primarily from carry as opposed to further spread tightening. Turning to our holdings, the non-agency portfolio increased modestly in the third quarter to $2.1 billion from $2 billion as of June 30, 2021. The themes I mentioned in Q2 with respect to our portfolio activity generally continued. We continue to rotate a portion of our CRT holdings in the lower credit tranches, which we believe will enhance the return profile of our CRT portfolio based upon the underlying strength in the residential conforming mortgage market. And then on the CMBS front, we were able to find some attractive investment opportunities in single asset, single borrower deals. Lastly, on the RMBS side, we increased our position in AAA private label securities. Looking forward, the overall supply backdrop has shifted favorably as Fannie Mae has returned to the market. Just last week, Fannie Mae priced their first deal since Q1 2020. While issuance plans for 2022 remain unclear, there will undoubtedly be more supply, which over time should lead to more attractive investment opportunities. That said, recent transactions have included a five-year call option that allows the GSEs to extinguish their credit protection at that time. This option will somewhat limit total return potential for bondholders. Finally, I'll quickly touch on the non-agency repo market. There continues to be meaningful competition to lend against non-agency securities which has reduced both repo costs and haircuts. At quarter-end, our average borrowing costs had declined to 72 basis points over the repo rate. Although the tightening and repo spreads have lagged the compression in asset spreads, it certainly has been a favorable tailwind. With that, I will turn the call back over to Peter.

Peter Federico, CEO

Thank you, Aaron. With that, we will now open the call up to your questions.

Operator, Operator

Ladies and gentlemen, we will now start the question-and-answer session. If you are on a speaker phone, please pick up your handset before pressing any keys to ensure the best sound quality. We will take a short break to put together the roster. Our first question today comes from Kevin Barker from Piper Sandler. Please go ahead with your question.

Kevin Barker, Analyst

Good morning. Thanks for taking my questions. It seems like the tone is shifting where you seem much more proactive in increasing leverage here in the near future, especially with some of the Fed's actions. I mean, are you seeing significant opportunity starting to develop especially in the near-term or do you expect that leverage to really increase over the coming months or coming quarters? Thank you.

Peter Federico, CEO

Sure. Good morning, Kevin. Thank you for the question. What I would say is first let me sort of give you some perspective of where we were and where we think we are now. If you think back to last quarter when we talked about our leverage position, I sort of described it as being in the sweet spot at 7.5 times, meaning we could take it lower if we expected mortgage spreads to widen further in there, to be volatility around the tapering or take it up opportunistically. And as it turned down in the third quarter, things stabilized quite a bit, and the way I would describe our position today, we're still at around 7.5, but we see much less downside risk in the agency MBS market. There could be certainly spread volatility in the tapering cycle, but spreads could in fact widen further. But any meaningful widening, we think will be met with strong investor demand, particularly because agency MBS look so attractive relative to other asset classes. Any cheapening, I think will be really quickly bought. So the way I would describe our position today is that we are more optimistic and more favorable with respect to the agency landscape and all other things equal, I do expect our leverage to increase over time. If you think back to where we operated on a historical basis, it was really more something like 8.5 times to 9.5 close to 10 times would be our more normal operating range. In an environment where we are optimistic about agency MBS as well as the interest rate environment, and that's the one piece that we're still trying to communicate in our prepared remarks. We're still a little cautious about the macroeconomic environment because there are a lot of moving pieces right now. The Fed has a lot to do with respect to its inflation and its employment. And there could be potentially more interest rate volatility. So we're being cautious in our leverage position, but all that said, we do expect it to improve and increase over time, but we're going to do so really deliberately, really measured, and really try to be opportunistic with our investment choices. And we think we have the ability to do that. We're in a strong earnings position right now. So we have a lot of upside, but we want to be patient with our investment decision.

Kevin Barker, Analyst

Okay. And then just a follow-up on some of your prepared comments, and correct me if I'm wrong, but it appeared that you expect more of the incremental economic return for shareholders to be driven more by dividends or earnings versus book value. Am I interpreting that correctly, or how should I interpret your prepared comments?

Peter Federico, CEO

Yeah. It's an interesting observation what I would say is if you look back at last quarter, which is a great example of I think what you just described in an environment where book value was really stable, just a slight positive. Essentially, all of our economic return was driven by our 9% annualized dividend. So that's very positive, and generally speaking, we are seeing more stability in book value from agency spreads right now. That continues to be the case into October here. As Bernie mentioned in her prepared remarks, our book value was slightly positive. As we sit today, it's probably up around 0.5%, maybe a little more than 0.5% in October because mortgage spreads, again have been stable, higher coupons have outperformed slightly. Again, if that were the case, then your conclusion would be right that the majority of our economic return will be driven by the return of our dividend.

Kevin Barker, Analyst

Okay. Thank you for taking my questions.

Peter Federico, CEO

Sure. Thank you.

Bose George, Analyst

Good morning. I wanted to follow up on your comments regarding TBA and the spread widening. With the tapering starting, it is likely to be modest. Could you provide some quantification on that? Do you think it could be around 10 to 15 basis points if there is strong demand, or are you interested in understanding how you see that developing?

Peter Federico, CEO

Yeah. Hi Bose. Good morning. Interesting question and the answer is we don't know. But I mean, if you look back historically, mortgages still do look tight on a historic basis. You can make the case that if you look back to previous cycles, maybe they could be 25 basis points wider. But we don't think that 25 basis points would be the right number in the current environment given where other returns are, given the interest rate environment, given asset valuations, generally speaking. We think that the right level for mortgages is here, or maybe slightly wider. But again, it's too soon to tell and we don't know how it's all going to play out. But at the end of the day, the key for the mortgage market is not only the Fed being really patient and deliberate in the way it's tapering. It also will be driven a lot by what the Fed does once the tapering is done and the reinvestment policy, and they've made some comments on that. But generally speaking, we think the Fed is going to be reinvesting paydowns for a considerable period of time, and that's going to be a really positive technical for the mortgage market. In addition, if we're right and the economy recovers and rates are higher, that means there's going to be less supply of mortgages, at the same time, the Fed will continue to buy a lot of mortgages to replace its runoff. So the environment could shape up pretty well for the mortgage market, but that's going to have to unfold over time. And then, of course, we think just generally speaking, mortgages from other investors' perspectives are relatively underweight. I think there's going to be a lot of demand for agency MBS. So there could be some spread widening but we don't expect it to be anything like we saw in previous cycles.

Bose George, Analyst

Okay, great. That's helpful. Thanks. And then just switching over to TBA, this level of specialness. How does that look so far? In the fourth quarter and just looking out into next year, especially given what you mentioned with the Fed, how do you think TBA's specialness will look next year?

Peter Federico, CEO

Sure. I'll have Chris give you some more details on that. But just generally speaking, we expect that to remain really fairly attractive through 2022. Chris, go on.

Chris Kuehl, CIO

ROE performed very well during the third quarter, currently trading around negative 30 basis points for 2s and 2.5s, which make up the majority of production in 30s. This negative 30 basis points reflects approximately 40% to 45% basis points of specialness compared to repo. Despite tapering, the technicals are expected to remain strong. Implied financing rates may trend slightly weaker, but I believe they will continue to trade above long-term historical averages for an extended period. Our ROE position is likely to stay high, in the range of $20 to $30 billion, likely leaning towards the upper end. The market conditions for ROE are highly supportive. Even with tapering, as previously mentioned, the Fed is expected to add around $180 billion in mortgages on a net basis between now and the middle of next year. If we use QE3 as a reference, the Fed will probably continue reinvesting runoff well into the next rate-hiking cycle, which took nearly three years to begin tapering reinvestments after QE3. After ceasing balance sheet growth by mid-next year, they are likely to remove an estimated $40-50 billion of the worst to deliver from the float each month for reinvestment in paydowns, depending on rates and prepayments. This likely will continue into the next rate-hiking cycle and is a crucial dynamic for the market. Previously, the markets did not benefit from a consistent removal of the worst to deliver float month after month with such regularity and magnitude. We believe ROEs will continue trading above historical averages for quite some time.

Bose George, Analyst

Great, thanks. That's helpful.

Peter Federico, CEO

Thanks, Bose.

Doug Harter, Analyst

Thanks. Peter, hoping you could talk a little bit about how you're approaching hedging the portfolio given the comments about the potential inflationary concerns and risk to rates.

Peter Federico, CEO

Certainly. First, I believe we are in a situation where we will remain active in our hedging strategy due to current interest rate conditions. We are operating with nearly a 100% hedge ratio and a small duration gap. Our goal is to maintain a well-managed interest rate risk profile that is historically low, considering the possibility of interest rate fluctuations. It's also essential to evaluate our hedge portfolio in relation to our asset portfolio composition. We will continue balancing our assets between lower coupon TBAs, generic MBS, and higher coupons, as they have different hedging requirements. Currently, our hedge portfolio is well distributed across the duration curve, with about one-third of our hedges in the 3 to 5-year sector, another third in the 5 to 7-year sector, and the remaining third in the 7 to 10-year sector. This balance is crucial. We have increased the optionality within our hedge portfolio, which is particularly relevant if we experience greater interest rate volatility. As mentioned, we've added significant optionality, including substituting some swaptions and introducing additional ones, which now make up around 20% of our hedge mix. Moving forward, we will likely keep adding options and maintain a high hedge ratio. If interest rate volatility rises and there are uncertainties surrounding the Fed's rate decisions, I believe the area of the curve most affected will be the five-year segment. Therefore, we may focus more on that sector for our hedging strategy in such an environment. Those are my high-level thoughts regarding our approach to hedging.

Doug Harter, Analyst

Great. And then just following up as you were talking about portfolio construction, this covers whenever it may be the TBA specialness normalizes. I guess, how do you think about portfolio construction? The mix between TBA and other securities in that environment whenever that may be.

Peter Federico, CEO

Yeah. Well, first off, I think that that's ways away. As Chris mentioned, I expect us to have a sizable TBA position given the outlook that Chris just gave with respect to specialness, well into 2022 and maybe into 2023. So I think we're a long way away from that, and I think that the movement down in specialness will be gradual when it does start to happen. But as you recall, there is typically always some level of specialness between the TBA and an on-balance sheet pool and historically it's probably 10-20 basis points, not 50 that Chris just described. So there is always some benefit but then of course there's the trade-off and between the incremental return that we pick up from the TBAs and the underlying characteristics that we might be getting delivered, Chris just described that as being very favorable over the long run. That's really the question that we have to make from a portfolio perspective and we have to make that on a real-time basis. So I can't really sit here today and say how the portfolio composition will change that far forward. But at the end of the day, we are always looking at those variables and trying to give ourselves the best diversified portfolio that gives us the greatest book value stability over the greatest range of rates, and give us the ability to generate the best carry we can for our shareholders so that we can generate the best economic return we can.

Doug Harter, Analyst

Thanks, Peter.

Peter Federico, CEO

Sure. Thank you, Doug.

Eric Hagen, Analyst

Hey, thanks. Good morning. With mortgage rates just over 3% right now, premiums for higher coupons, spec-pools have held up pretty well. I guess the question is, what kind of sensitivity do you envision there, if we're looking at mortgage rates pushing higher? And then can you also share the kind of mark-to-market sensitivity those bonds might carry at the short end of the curve.

Peter Federico, CEO

Yes. Sure. Eric, Chris will take that and then I'll chime in.

Chris Kuehl, CIO

Yes. So with respect to higher-coupon seasoned SPAC, the important thing is that prepayment burnout has been a pretty consistent theme now for the last several months and given that we think valuations look fair, plus or minus 25 basis points durations. These bonds should continue to trade to pretty short durations. There's still priced to fast prepayment speeds, which means that they have a fair amount of upside into higher rates. And so for that reason, as Peter mentioned, these positions really complement our lower coupon holdings well, given that they'll benefit in some of the scenarios that are more difficult for lower coupons. Steeper curve, higher vol, wider park coupon spreads, and the positions effectively help flatten that convexity profile of the mortgage portfolio.

Peter Federico, CEO

And Eric, what I would add to that is what we're seeing in the current environment is, as Chris described, gradual improvement in the prepayment outlook. And we're seeing burnout start to reveal itself and we expect that to continue. But we're also seeing the price changes of higher coupons reflect the progressions through the prepayment environment. Those positions have, as you well know, have been prepaying exceedingly fast for now 5 quarters, but each month and each quarter that we move past another high prepayment speed, the price of those securities are improving. We saw that last quarter, is why the higher-coupon prices went up, as we put another quarter of fast prepayment speeds behind us. Those positions are not carrying if you will, their current yield on those positions at a 30 CPR is not very attractive. So each quarter that those prepayment speeds pass, the prices are improving. We expect that to continue. And then just to round this out to your point about the hedging, that was why I made the comment with respect to the composition of our portfolio and having a significant amount of our hedges on the shorter end of the curve, the 3, 4-year, 5-year part of the curve. Those hedges give us a lot of protection against this position as well as operating with a positive duration gap to give us some protection against mortgages underperforming in a down-rate scenario. So I hope that answers your question.

Eric Hagen, Analyst

Yeah. That was really helpful, maybe a quick follow-up on the conversation around burnout and speeds more generally. Can you guys share how you incorporate expectations for home price appreciation and modeling prepayment speeds?

Chris Kuehl, CIO

With mortgage rates rising significantly from their previous lows, we are likely to see an increased focus on cash-out refinancing. The appreciation in house prices is advantageous from a mortgage investor's viewpoint. This housing turnover improves the convexity of mortgage positions as rates rise, which can be beneficial for risk management if rates continue to climb. We can still expect relatively fast turnover in the market.

Eric Hagen, Analyst

Good stuff. Thank you very much.

Chris Kuehl, CIO

Thank you.

Trevor Cranston, Analyst

All right. Thanks.

Peter Federico, CEO

Good morning.

Trevor Cranston, Analyst

One more question about the taper. You mentioned some of the macro uncertainties that exist. Is there a risk that the Fed might alter the taper timeline from its current baseline expectation if there are growing concerns about inflation? If the timeline were to change, how do you think the market would react?

Peter Federico, CEO

It's a good question, Trevor. The answer is that we don't know. The Fed has been clear about its preferred approach. In the second quarter, there was a lot of discussion within the Fed, with some members wanting a faster tapering timeline while others preferred the approach taken previously. They seem to have compromised on an 8-month plan. They have indicated that they are ready to start initiating changes, so I would be surprised if they don't proceed with that. However, during this 8-month period, they have the flexibility to either slow down or speed up the process. I'm sure they won't fully commit to a specific path, but they might indicate their direction. If they do commit, it would likely be beneficial for market stability, yet I don’t believe they will do that and will keep their options open. You’re correct that there is always a risk involved, which could lead to some market volatility; this is why we remain somewhat cautious and see potential investment opportunities at that time. On the other hand, even if they choose to accelerate the tapering, as Chris noted, they will be reinvesting cash flows. In the end, they will purchase a significant amount of mortgages next year, increasing their balance sheet and adding to their mortgage holdings while maintaining that balance for a while. The key conversation for next year will revolve around how long this reinvestment period will last. We'll have to wait and see, but we believe it will be considerable.

Trevor Cranston, Analyst

Okay. That makes sense. I think all the rest of my questions have been asked and answered. Thank you.

Peter Federico, CEO

Thank you.

Rick Shane, Analyst

Hey, guys, thanks for taking my question. Most of them really have been asked and answered, but I just want to delve in a little bit on what we should take from the hedging, actually the tactical moves in terms of hedging during the quarter. You increased the swap position, as you mentioned, you reduced the treasury short modestly, you kept the swap position flat. I think that what that suggests is that your view is that rates are going to be lower for a bit longer, but still ultimately strategizing for a more hawkish Fed and higher rates.

Peter Federico, CEO

We have made significant changes to our hedge composition recently. At the start of the year, we added numerous longer-dated hedges, which yielded benefits in the first quarter as we anticipated a steepening yield curve. However, the opposite occurred in the second quarter with a flattening yield curve. I believe there remains a fair amount of volatility related to the yield curve's shape. As the Fed and the market adjust short-term rate increases, it will influence the curve's formation. We have balanced our curve position accordingly, and our current hedge portfolio is geared towards generating additional value in a flattening scenario, providing us with a macro business hedge. While we expect rates to remain relatively stable, we now lean towards the belief that rates will be higher rather than lower, likely stabilizing between 1.5% and 2% for the 10-year. This range would be beneficial for the agency MBS market, and we would be pleased with that outcome, as we think mortgages would perform well in this context. Compared to last quarter's discussion of two-way risks, we now see greater exposure to upward risks, albeit gradually. Additionally, options offer us significant protection against large market shifts. Currently, our options portfolio stands at $13 billion, with a strike price of around 1.87%, below 2%. Should the economy strengthen as we expect, leading to increased Fed activity, interest rates will likely rise, and our options will protect us from significant fluctuations. We anticipate increasing our options position over time.

Rick Shane, Analyst

Got it. From your perspective, is the current environment for hedging a bit easier? You seem to have less concern about spreads widening at this moment, with more emphasis on a tendency towards higher rates rather than a binary or two-way market. I know it's early, and I apologize for the question, but I just want to confirm that you feel somewhat more comfortable managing risk right now.

Peter Federico, CEO

Well, I would like to say yes, but there's one caveat to that which I think is a challenge, which is there could be more volatility in the shape of the curve. So hedge location is a little bit more challenging if you think about what could happen as the market prices the Fed's reaction function; it'll have a lot of impact on the shape of the curve. If the market thinks that the Fed is behind on its inflation objective and slow to react, the yield curve will steepen significantly. And so you'd want to have your hedges in that part of the curve. Conversely, if the market thinks that the Fed's behind on its inflation and that they're going to take actions quickly and pull forward rate moves, it's going to have a flattening effect on the curve. We've seen that just unfold in the last 30 and 60 days with curve movements like that. So I think that's the one part that makes it challenging. So that's where you have to be a little bit more active in your hedging in terms of moving hedges from one part of the curve to the other in order to generate some incremental value. That's the challenging part, is the market pulling forward or moving back rate moves, and that could be the dominant question in 2022.

Rick Shane, Analyst

That's really helpful. Thank you so much.

Peter Federico, CEO

Sure. All right. Thank you so much for it.

Operator, Operator

And ladies and gentlemen, with that, we'll be ending today's question and answer session. I'd like to turn the floor back over to Peter Federico for any closing remarks.

Peter Federico, CEO

Thank you. That concludes our third-quarter call. We appreciate everyone's participation on the call today, and we look forward to speaking to you again next quarter. Thank you very much.

Operator, Operator

And ladies and gentlemen, with that, we'll end today's question-and-answer session and today's conference call. We do thank you for attending. You may now disconnect your lines.