Last week was all about Treasurys and equities. The yield on the 10-year Treasury dropped below 4% and is at levels not seen since the days of Camelot. Further support for Treasurys came from mortgage participants adding duration or hedging their portfolios. Over the Wednesday-to-Wednesday period, spreads on 30-year Fannie Mae 6s through 7s moved out eight basis points, and 7.5s and 8s widened by 17 and 23 basis points, respectively. The 15-year sector was hit hard as well with spreads 16 basis points weaker for 5.5s through 6.5s.

Flows were mixed as heavy originator selling has yet to materialize and selling averaged about $1 billion per day. The selling, however, was primarily in 5.5s and 6s. According to Lehman Brothers, originators have become more confident in selling 5.5% coupons over the past few days. As a result, liquidity in that coupon may start to improve. Overall investor flows for the week favored selling versus buying. Selling of mortgages to move into Treasurys was noted, and what buying took place focused on 15-year 5s and 30-year 5.5s.

The near-term outlook for mortgages is concerned with supply, prepayment, and volatility risk. In addition, the one big plus for mortgages - carry - has weakened some. The roll on 30-year 6s is down to 8.125. Also, of note is CMO buying in 6s apparently has slowed as the dollar price is at a substantial premium.

The lofty prices have also made banks less supportive and slightly better sellers. According to Greenwich Capital Markets, the markets will be scrutinizing every bit of economic data and the FOMC's potential response which will keep prices choppy. In addition, Greenwich recommends not to expect much over the short term with no discount coupons in the front end of the month. "Even our normal enthusiasm for the events on the calendar (non-farm payrolls, prepayments, and calendar flip) has waned," they say.

For the week ending August 30, the Mortgage Bankers Association reported mortgage applications were mixed. The Purchase Index rose 4% to 360, while the Refi Index fell 4% to 5130. As a percentage of total applications, refinancings were 70.9%, down from 72.1% in the previous report. Also, the share of ARM activity decreased to 12.4% from 13.8%.

With many away on vacation or focused on the start of the school year, it was expected that the Refi Index would fall. Also, many borrowers are waiting for further declines in mortgage rates before beginning the refinancing process. They may get it this week as rates fell further. With vacations and Labor Day behind, it is expected the Refi Index will start heading higher and top 6000 in the weeks ahead. Also, with fixed rates at record lows, the percentage of ARM applications is expected to decline. This suggests that fixed rate supply may be greater than was originally expected.

Freddie Mac reported last Thursday that for the week ending Sept.6, fixed rate mortgage rates hit a new record low. The 30-year fixed mortgage rate declined seven basis points to 6.15%, and 15-year fixed rate mortgage rates fell eight basis points to 5.56%. The one-year ARM rate gained one basis point to 4.35%.

"The refinancing wave of the last six weeks is now on pace to eclipse the unprecedented refinancing activity that we saw last October and November," noted Phil Colling, MBA economist. "The interest rates that existed last week are comparable to those of 1963. This has been brought on by a weaker-than-expected economy, no signs of inflation and the flight to quality' phenomenon that results when investors pull money out of stocks and invest in bonds, which drives down interest rates."

At this time, prepayments are expected to peak in October. With rates holding, it would seem likely that November and December's reports may see speeds holding at peak levels before coming off. Current peak estimates for Fannie Mae and Ginnie Mae MBS are shown on the table. On Monday, Sept. 9, the housing agencies release prepayments for the month of August. Dramatic gains are expected.

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