The MBS sector was off to the races as 2012 trading got underway and participants returned from the year-end holiday break. Books opened back up while the supply/demand technical outlook appeared very favorable.
The week wasn't all about technicals, however, with the Federal Reserve indicating that its goal for 2012 is to get the housing market back on track sooner as opposed to later.
Volume picked up to a 111% average through Thursday from 89% and 75%, respectively, in the final two weeks of 2011, according to Tradeweb's experience.
Excess return month-to-date on Barclays Capital's MBS Index was at 19 basis points in the first three days of trading after closing up 17 basis points for December.
Given the risk preference at the start of the New Year, MBS lagged CMBS (+73 basis points) and Corporates (+29 basis points).
Meanwhile, the 30-year current coupon yield declined to 3.0% from 3.03% at year-end with the spread to 10-year notes tightening to +103 basis points from +115 basis points.
Mortgage banker selling was indeed limited at about $1 billion per day, on average, which was barely enough to satiate the Fed's appetite of $1.05 billion per day based on their latest weekly purchase report.
Other investors were generally influenced by price movements and 10-year note yield levels. For example, a sharp sell-off on Tuesday happened as investors went after risk. This movement eased MBS prices with the 10-year note yield jumping from 1.873% as of the end of 2011 to 1.961%.
This led to broad-based participation from real money investors, banks, hedge funds, overseas buyers and other purchasers across the coupon stack and sectors (10- through 30-years). Generally at this time, better buying occurs when 10-year note yields are at or above 2.0% while lower yields lead investors to the sidelines or to take profits.
Flows turned more two-way at mid-week and into Friday as risk aversion began to rise against Europe, which pressured prices higher and yields lower, even in the face of better-than-expected employment news. Additionally, within the coupon stack itself Refi.gov worries reared their ugly head again on rumors and Fed talk that led to profit taking in 4.5% coupons and higher, and buying in 3.5s and 4.0s.
In other mortgage related activity, specified pool activity picked up significantly as the week progressed with over $20 billion in origination pools as Class A pool allocations approach. The Treasury was also active with over $2.0 billion in BWICs.
The supply was said to have been easily taken down by money managers, REITS and CMO desks. GNMA/FNMAs were pressured lower due to a proposal by the Fed that would classify GSE MBS as "highly liquid asset" in the same as GNMAs are under the Liquidity Capital Ratio (LCR) test under Basel III.
Specifically, GNMA/FNMA 4.5 which was at 3-01 points (Tradeweb) in mid-December was back to 2-17 at mid-day today. Also notable was that FNCL 3.0%s were on the radar with some very modest trading noted from servicers and CMM desks. The coupon is above par at 100-23+, up 14+ ticks since year-end.
Fed Begins Full Court Press for Housing Recovery
Chairman Ben Bernanke released a white paper on Wednesday to the heads of the Senate Banking and House Financial Services Committees on The U.S. Housing Market: Current Conditions and Policy Considerations that outlined actions along three dimensions that policymakers could take to help the housing market to recover.
These three areas included moderating the inflow of properties into the large inventory of unsold homes such as through an REO-to-rental program; removing some of the obstacles preventing creditworthy borrowers from accessing mortgage credit, such as through additional enhancements to the Home Affordable Refinance Program (HARP); and limiting the number of homeowners who find themselves pushed into an inefficient and overburdened foreclosure pipeline such as changing the structure of mortgage servicer compensation.
In a speech on Friday, Federal Reserve Bank of New York President William Dudley reiterated much of what was mentioned in the white paper. He concluded that "with additional housing policy interventions, we could achieve a better set of economic outcomes than with just monetary policy alone."
Meanwhile, Federal Reserve Bank of Boston President Eric Rosengren was on Friday morning also added his support for adjustments to the GSE mortgage programs and making more MBS purchases to aid the housing market's recovery and with it, the broader economy. Fed Governor Elizabeth Duke was also slated to discuss housing later in the day.
Morgan Stanley analysts suggested these moves from the Fed increase the probability of further enhancements to the HARP.
While flows were more mixed in the latter half of the week the sector still retained a supportive tone due to the aforementioned supply/demand dynamics. There was also the added prospects of a third round of quantitative easing (QE3) and MBS purchases providing a backstop for the sector.
The report released by Bernanke as well as comments from the minutes of the last Federal Open Market Committee (FOMC) meeting would suggest odds remain favorable that the Fed will engage in further quantitative easing later this year.
Morgan Stanley analysts also believe that the white paper increases the probability of QE3 centered on MBS given the paper's focus on the poor state of the housing market and how it is impeding the economic recovery. Likewise, a Primary Dealer Policy Expectations Survey by the New York Fed also indicated high expectations along the Street for additional Fed actions.
Comments included in the FOMC Minutes from the mid-December meeting relayed concerns regarding Europe and fiscal tightening in the U.S. and how it may adversely impact the economy's growth. Committee participants also saw few signs of recovery in the housing market with home prices continuing to decline in most areas of the country.
In the primary dealer survey, respondents were questioned on the probability of the various tools the FOMC would use in the event of further easing. The highest median response - at 60% within one year - was expanding the System Open Market Account or SOMA portfolio through security purchases with the comment that several dealers believing that the operation would be carried out using agency MBS.
The majority also didn't expect the Fed to increase the Fed Funds target rate until after 2Q14. Contributing to this outlook were projections of anemic economic growth and continued high unemployment.
