Mortgages saw active two-way flows last week. Of particular note was a pickup in originator selling as the market continued to back up following strong upward revisions made to employment and comments from the Federal Reserve minutes saying that inflation risks remain. Daily average selling was near $2 billion, versus a normal daily average of $1 billion. Supply consisted largely of 6s and, to smaller extent, 5.5s.
The recent backup did encourage buyers in mortgages to appear, notably Asian investors as yield levels and prices became more palatable to them. Domestic investors included a variety of real and fast money types, including servicers. Buying was both up and down the coupon stack.
Last week was pool settlement for both 30-year conventionals and 15-year mortgage-backeds. Roll trading was generally uneventful, although the FNMA 5.5 roll got a surprising pop. JPMorgan Securities strategic principal trader David Montano noted in a daily comment that demand from structured products desks was larger than anticipated and caused a modest distortion, which pushed the roll higher.
Mortgages gave up some performance gains, in part, due to an uptick in volatility. According to Lehman Brothers, month to date through Wednesday, Oct. 11, the MBS Index is up four basis points compared to 10 basis points over Treasurys for the first week of October. Year-to-date, mortgages have outperformed Treasurys by 63 basis points.
The outlook in mortgages remains directional with analysts' recommendations generally to trade the range: selling on strength and adding on weakness. Deutsche Bank analysts said that despite wider spreads, they don't believe mortgages will be remarkably tighter by the end of the year. Of particular concern to them is the high net supply outlook for the remainder of the year and the lack of a consistent buyer base to absorb this supply.
Deutsche analysts project net supply of 30-year agency MBS will be around $25 billion per month for the remainder of the year as a result of the pickup in refinancing activity. JPMorgan is predicting similar supply levels, and add that at this pace net growth for 2006 should exceed $300 billion and surpass the supply observed in 2001.
The demand side of the equation is becoming worrisome too as there doesn't appear to be a "marginal" buyer to take down all of the supply. The GSEs remain out, while foreign buying has been limited. Deutsche analysts add that domestic commercial banks still have a large amount of discount MBS on their books at a substantial discount to book price, and implementation of FAS 155 may limit banks' willingness to add to their CMO positions for some period of time.
Mortgage application
activity falls 5.5%
Mortgage application activity declined for the week ending Oct. 6 despite mortgage rates holding stable in that week. According to the Mortgage Bankers Association, the Purchase Index fell 5.3% to 383.3, while the Refinance Index declined 5.8% to 1857. There was expectation that the Refinance Index would move above 2000 in response to the more favorable rate environment. Still, the level is the second highest reading for this year and the highest since late October last year. Refinancing activity has been heavily influenced by ARM-to-fixed refinancings.
Mortgage rates move higher
Mortgage rates rose seven to 10 basis points last week as the market readjusted to reduced odds that the Federal Reserve would be cutting rates in the near future. According to Freddie Mac's weekly survey, the 30-year fixed mortgage rate averaged 6.37% for the week ending Oct. 13, versus 6.30% in the previous week. The 6.30% was the lowest the rate had been since early March. A year ago, the 30-year mortgage rate was at 6.03%, and was the first time since the end of March 2005 that rates had crossed 6.0%.
In the other borrowing programs, 15-year mortgage rates rose eight basis points to 6.06%. Both 5/1 hybrids and one-year ARMs rates gained 10 basis points to 6.10% and 5.56%, respectively.
"Renewed concern that inflation is still an issue put some upward pressure on bond yields, which generally translates into higher interest and mortgage rates," said Freddie Mac's Chief Economist Frank Nothaft. "ARM rates especially felt the weight of increased inflation fears, narrowing the gap between ARMs and fixed-rate mortgage rates. Thus, ARMs may become less desirable."
Prepayments in October expected to rise
Initial prepayment estimates have speeds in October increasing around 10% to 12%. Factors influencing the predictions include one additional collection day and increased refinancing activity. For the month of September, mortgage rates averaged 12 basis points lower, versus August's average, and contributed to a 10% increase in refinancing activity on average in September from August.
Looking further out to November, the outlook is for speeds to be little changed from October - despite a decline in the day count to 20 from 21. The strength is primarily due to the higher refinancing activity.
Merrill Lynch analysts said to expect prepays to gain 2% to 5% in October, noting that an extra business day helps offset slowing turnover. However, they said that the real story would lie in premiums. By October, the effect of the August and September rallies should be felt, and analysts said that it would be very interesting to found out how much of a jump there would be in premium speeds.
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