Mortgages got relief last week as rates moved away from 4.40% on the 10-year Treasury as a result of a stronger than expected ISM Services Index Tuesday and a strong ADP National Employment report on Wednesday that raised concerns about last Friday's employment report. The ISM Services Index rose to 58.9, which is the highest it's been since May. Consensus had forecasted a decline from the previous report. The ADP report calls for total private nonfarm employment to have risen by 158,000 in November. The median estimate has nonfarm payrolls increasing just 110,000 in November with upward revisions for October. At Wednesday's close, the 10-year yield was 4.480% compared to 4.427% as of Friday, Dec.1.
The first half of the week saw active buying in heavy volume with flows moving up in coupon into 5.5s through 6.5s. Flows out of discounts into higher coupons were estimated at $5 billion to $7 billion. Both real and fast money were participating in this trade. Asian buying was also a steady buyer throughout most of the week. Interest was focused primarily in the higher coupons as they've lagged in the recent rally. Also encouraging interest is the curve steepening and possibly year-end window dressing needs. Originator selling averaged its normal $1 billion per day, down from around $1.5 billion last week.
On Thursday, mortgages were lagging Treasurys despite steady rates and paydown reinvestments. The sector was feeling the weight of some bid lists on top of the heavy dealer inventories and fast money selling. In particular, regarding the bid list activity, Wednesday afternoon saw a bank selling a large amount of MBS with coupons ranging from 5% to 7% as part of a hedge related to a whole loan package. On Thursday, there was a $1.3 billion current face of 20-year paper consisting primarily of 5.5s.
Meanwhile, dealer inventories are at a multiyear high of $56 billion as of the Nov. 22 close. This is the highest inventories have been since late July 2003 when positions were in the low $60 billion area. In December of last year, dealer inventories were less than $20 billion. RBS Greenwich Capital analysts recently said that selling by banks as a result of mergers or strategy shifts to loans have contributed to the high levels and made it difficult for dealers to reduce their positions as they head into their fiscal year-ends. Deutsche Bank analysts also pointed out recently that dealers are having a more difficult time marketing fixed rate CMOs and specified pools as investors have been more interested in floating and ARM cash flows.
Also impacting the market said Alec Crawford, head of agency MBS strategy at RBS Greenwich Capital, was news of a small subprime lender declaring Chapter 7 bankruptcy. This was contributing to a widening in swap spreads - out 1.5 basis points as of midday Thursday.
Full calendar this week
This week's calendar is full of data, including the Federal Open Market Committee meeting on Tuesday with a statement due out at 2:15 p.m. Other data include: wholesale trade on Monday; the trade deficit and Treasury Statement on Tuesday; retail sales and business inventories on Wednesday; import prices on Thursday; and CPI, Empire State Manufacturing Survey, TIC Flows and industrial production capacity utilization on Friday. In addition, the Treasury auctions $8 billion in 10-year paper on Wednesday with a reopening of the 4.625% of 11/2016. In mortgages, Thursday begins 48-hour notification in 15-year MBS and on Friday with 30-year GNMAs.
JPMorgan Securities analysts suggested midweek for investors to stay overweight despite the risks that the rally has brought as the recent selloff could allow the range to remain intact for a while longer. They estimated that a rally of 25 basis points would put 5.5s into refinance territory. Volatility would also likely move higher and supply would increase. As analysts don't believe that Asian buyers or banks could absorb this supply in a short period of time, there would likely be some short-term widening in spreads, they said. They favor up in coupon, in part on increasing supply potential in 5s if mortgage rates remain around current levels or lower and also from additional bank selling to move into higher coupons and loans.
Bear Stearns, however, has shifted to neutral from bullish. Refinance risk is too close for comfort, they said, and they are concerned with an uptick in volatility and supply as a result. Bear analysts acknowledged though that demand from both banks and overseas remains reasonable.
Refi activity jumps
Mortgage application activity rose in the week ending Dec.1 as borrowers responded to the lower mortgage rates. According to the Mortgage Bankers Association, the Refinance Index jumped 13.7% to 1989.7, while the Purchase Index was up nearly 5% to 426.6. For November, the Refinance Index averaged 1919, up nearly 8% from October's average as mortgage rates averaged 6.24%, 12 basis points lower than in October. A year ago, the Refinance Index was at 1596.
As a percentage of total application activity, refinancings were 50.1% versus 46.9% in the previous report. The MBA reported this is the highest share since April 2004. ARM share fell to 23.9% from 24.5%, and is at its lowest since October 2003.
30-year mortgage rates lowest since January
Last week mortgage rates declined another three basis points in 30- and 15-year fixed rate mortgages, as well as in five-year hybrid ARMs and one-year ARMs, according to the Freddie Mac weekly mortgage survey. The 30-year fixed mortgage rate averaged 6.11% and is at its lowest level since the latter half of January of this year. A year ago, the 30-year rate was at 6.32%. Meanwhile, 15-year fixed rates were 5.84% compared to 5.87% a year ago, five-year hybrid ARMs reported at 5.92%, and one-year ARM rates were 5.43%.
Current levels should continue to stimulate refinancing activity. JPMorgan analysts believed last week's print on refinancings was relatively weak given the level of mortgage rates. The Refinance Index could break 2000 in the next report, they said. They added that despite the rally, current levels aren't likely to stimulate premium speeds in a meaningful way in December.
November prepay recap
Speeds on FNMA MBS were pretty much in line with expectations. However, speeds slowed more than expected for par and premium coupons. For example, higher coupons were estimated to slow around 2% to3% from October, although they were down around 8%.
Premiums also surprised in October when speeds on seasoned 6s and 6.5s increased much less than expected. Lehman Brothers believed that part of the reason for the lack of response of the higher coupons is due to lower pull-through rates as a result of the rally in November. In addition, a lot of premium paper has high spread at origination (SATO) and the slowdown in home price appreciation could be contributing to the slower speeds.
Gold speeds also were generally in line with expectations on discounts, but declined more than expected for par and premiums. Speeds, however, declined less than FNMAs for many coupons and vintages. Speeds on FHLMC Golds are mostly converged with FNMAs now.
The Ginnie Mae report was mixed with sharp slowing in 2004 and 2003 5s of 12% to 13% versus expectations of half as much. Seasoned par and premiums also showed stronger than expected slowing, while less seasoned paper was more in line with expectations. Finally, 2005 6% coupons increased 22% from 14 to 17 CPR.
Paydowns totaled $36.5 billion, according to JPMorgan analysts. They estimated fixed-rate net issuance fell to $19 billion with conventional 30s at $24 billion and 15-year MBS at less than $5 billion.
Looking ahead to December, speeds are currently projected to decline in the 10% area from November. While refinancing picked up in November on more favorable interest rates, it is expected to be more than offset by one less collection day and seasonal factors.
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