Last week mortgages experienced active buying as investors anticipated that the Federal Reserve is close to an end to its rate hike campaign. This was further encouraged by Wednesday's Beige Book report that observed slowing in the economy. Of particular note was the presence of Asian investors after a long dry spell that began in mid-March. They are expected to become even more supportive when the Fed actually pauses.
Though flows initially were up in coupon by midweek they started to reverse course and move down in coupon. JPMorgan Securities strategic principal trader David Montano said that convexity was beginning to take a toll on premiums as the sector struggles with the lack of a steep curve and the level of rates versus the Fed Funds rate.
In addition to the better buying support, mortgages benefited from a down tick in volatility, tighter swap spreads and the range bound market. Meanwhile, originator selling held to its $1 billion per day average level.
The improved tone in mortgages moved performance further into positive territory last week. According to Lehman Brothers, month-to-date excess return versus Treasurys on the MBS Index through July 26, is nine basis points over Treasurys with year-to-date at 40 basis points over.
Street analysts also have become more positive on the sector since Fed Chairman Ben Bernanke spoke. For example, Lehman is holding with its overweight due to the favorable demand outlook of a return of the Asian bid when the Federal Reserve stops and steady bank buying. This could be further strengthened by a return of the carry trade. JPMorgan analysts remain "moderately positive" on the mortgage basis also due to bank and Asian support, a moderating Fed stance, as well as the potential for lower volume. Regarding Asian participation, JPMorgan believes the Asian community has a fair amount of money that they are waiting to invest when the Fed is done. "Once this occurs, we expect Asian sponsorship to move out of short duration, floating rate instruments and out the curve," JPMorgan analysts wrote.
Ongoing concerns, however, include the tension in the Middle East, slowing prepayments related to the less robust housing market and the potential that the Federal Reserve is not done raising interest rates.
Near-term outlook
This week starts out with potential support from month end buying on Monday. According to Lehman, the MBS Index is estimated to extend 0.06-years on Aug. 1, down from an original estimate of 0.08-years. The average July extension is 0.11-years. However, the 12-month average is 0.06-years. Other extensions include: +0.01-years for the Treasury Index; +0.07-years for agencies; +0.06-years for the Credit Index; and +0.05-years for the Aggregate. Volatility risks are anticipated to pick up, however, as the week progresses on the data, particularly with Friday's employment report and the approaching Federal Open Market Committee meeting on Aug. 8. At the same time, mortgages traditionally benefit from the drop in volatility following the non-farm payrolls report. In addition, Monday Aug. 7 will see around $35 billion in paydowns available for reinvestment.
Application activity
holds steady
Mortgage application activity slipped just 1.3% overall for the week ending July 21. The Mortgage Bankers Association reported that the Refinance Index was slightly higher at 1385.2 versus 1377.6 previously. The Purchase Index fell 2.4% to 389 and is at its lowest level since November 2003. A year ago, these indexes stood at 485 and 2320, respectively.
Freddie Mac's latest survey reported that mortgage rates declined last week as expected - particularly true for fixed-rates - on the rally inspired by Chairman Bernanke's Humphrey-Hawkins testimony. The 30-year fixed mortgage rate fell to 6.72% from 6.80%, while 15-year fixed rates were down seven basis points to 6.34%. On the adjustable side, 5/1 hybrid ARMs and one-year ARMs slipped one and two basis points, respectively, to 6.35% and 5.78%.
"Mortgage rates drifted lower this week on indications that economic growth is moderating, inflation remains under control and the Fed just may pause raising rates for awhile," said Freddie Mac Chief Economist Frank Nothaft.
Given the improvement in mortgage rates, expectations are for refinancing activity to hold near its current level. Since the beginning of June, the Refinance Index has held within a relatively narrow range of 1356 to 1499. Refinancing activity has remained higher than expected given the rate levels due to cash-out refinancings and ARM-to-fixed refinancing.
Prepayment outlook
The prepayment reports for July will be released Friday evening, Aug. 4, for conventionals, and on Monday, Aug. 7, for GNMAs. Speeds in July are predicted to slow 12% to 15% from June, primarily as the day count falls to 20 days from 22 days. With day count jumping to 23 days in August, speeds are expected to recover by around 8% to 10%. In September, speeds are predicted to slow 15% to 20%, due to slowing seasonals and due to a decline in collection days to 20.
FHLMC's retained
portfolio contracts
Freddie Mac reported last week that its retained portfolio in June contracted 1.4% annualized. In May, the portfolio experienced a negative 1.2% annualized growth rate. This brings year-to-date growth in the retained portfolio to 3.4%.
Retained purchases rose to $29.8 billion, up from $20.3 billion previously; however, they were more than offset by sales and liquidations. Sales totaled $13.8 billion, nearly triple from last month. Meanwhile, liquidations amounted to $16.9 billion, which was slightly higher versus May. Retained portfolio mortgage purchase agreements entered into in June were $19.1 billion, up from $15.7 billion previously.
Within the retained portfolio, purchases of Freddie Mac securities declined for the first time in five months by $6.3 billion, while purchases on non-agencies rose by $5.3 billion. The GSE's securities represented 51% of the portfolio in June, down from 51.8%. In the meantime, non-Freddie Mac mortgage related securities increased slightly to 49% from 48.2%.
The agency's total mortgage portfolio growth jumped 10.3% in June from 2.6% in May. Year-to-date growth stands at 10.3%.
The monthly survey reported total guaranteed PCs and structured securities issued totaled $28.9 billion compared to $25.4 billion in May. In terms of year-to-date activity, issuance is at $174.6 billion. After liquidations, the net increase for June was $9.6 billion versus $6.5 billion previously, and $70.2 billion year-to-date. Year-to-date annualized growth is 10.5%.
For the fourth straight month, delinquencies on non-credit enhanced single-family loans were lower at 23 basis points in May, down one basis point from April, and down seven basis points from its peak in December and January.
Freddie Mac also reported its duration gap remained at zero months, and that is portfolio market value sensitivity level stayed at 1%.
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