Mortgages had some relief last week as selling slowed down and buying picked up. It was a heavy data week with the key reports of fourth-quarter GDP, Chicago PMI, construction spending, personal income and outlays, ISM Index and employment. In addition, the Federal Open Market Committee met.

In general, the data reported decent growth in the economy, while the inflation information was encouraging. The FOMC held to the status quo, keeping rates unchanged and remarking that it remains vigilant on inflation. The committee did, however, acknowledge the slight easing in inflation pressures in recent data. After reaching a high of 4.892% at Tuesday's close on the 10-year Treasury - ahead of the data crush - Treasurys had rallied to below 4.80% by midmorning on Thursday. By midday, the 10-year had moved back above 4.80%.

Both real- and fast-money buying began emerging in mortgages as yields moved below 4.90%. Initial activity remained focused in the belly of the stack, but as the week progressed, discount coupons, particularly 5s, began to outperform. This was instigated by originators, correcting earlier selling via the 5.5%/5% swap. For example, by Thursday's close, FNMA 5s had rallied 11+/32s from the previous Friday's close, with 6.5s up just one tick. Over the same period, 10-year Treasurys gained 13+/32nds.

Asian investors were also a bit more active buyers over the week. Overall, however, they remained a limited presence in the market. In addition, Chinese New Year holidays are looming in mid-February, which will effectively shut down that area of world for the latter half of the month. Month-end indexers also put in an appearance on Wednesday, showing better interest than was initially anticipated. Lehman Brothers MBS Index was forecast to extend just 0.04-years on Feb.1.

Daily originator selling held to slightly above average levels - focused mostly in 6% coupons. Still, the supply/demand dynamics were turning more encouraging as the market strengthened over the week. This tends to reduce supply, while attracting better buying interest.

For January, mortgages' performance was even with Treasurys, according to Lehman Brothers. On one hand, that's disappointing considering they were up 25 basis points in the first week of January. On the other hand, this was improved from the negative nine basis points the sector had sunk to as of Jan.26 due to heavy selling, slightly upticks in volatility, and wider swap spreads. Mortgages also did better than ABS (negative nine basis points) and CMBS (negative 17 basis points).

Near-term outlook

Analysts' sentiment remains mostly favorable for mortgages. With the Federal Reserve on hold for the foreseeable future, mortgages should benefit. The higher yield levels are also expected to attract real money interest.

In a report, Bear Stearns analysts stated that their outlook for spreads remains favorable. They noted that while swap spreads have moved in the wrong direction recently, volatility remains low. Analysts from Bear expect that stable to tighter spreads in swaps, along with declining volatility, should help MBS rebound. Also benefiting the sector is anticipated demand from domestic banks and overseas investors.

Near-term events are also traditionally supportive for the mortgage sector. These include the payrolls report on Friday, Feb. 2. Volatility typically drops following the release. This is followed on Wednesday by reinvestment of January paydowns, estimated at over $30 billion. The week will also see roll related activity as pool notification begins on Thursday for Class A securities (30-year conventionals).

The economic calendar is on the lighter side this week with the ISM Non-Manufacturing Index on Monday, Productivity & Costs (pQ4) on Wednesday, and Wholesale Trade on Thursday. The Treasury Refunding also takes place with $38 billion being auctioned beginning on Tuesday with $16 billion three-years, followed by $13 billion in 10s on Wednesday, and concluding on Thursday with $9 billion in 30-years.

With the FOMC meeting passed, Federal Reserve officials will be making various appearances. In particular, on Tuesday, Federal Reserve Chairman Ben Bernanke is speaking before the Greater Omaha Chamber of Commerce. On Tuesday and Wednesday, respectively, Federal Reserve Bank of Chicago's Michael Moskow and Federal Reserve Bank of Philadelphia's Charles Plosser will be talking about the economic outlook. Also out and about this week are Federal Bank of San Francisco's Janet Yellen and Federal Bank of St. Louis's William Poole.

Slight increases in purchase and refi activity

The Mortgage Bankers Association reported modest increases in both purchase and refinancing activity for the week ending Jan. 26. The Purchase Index gained 1.3% to 408, while the Refinance Index was up nearly 5% to 1940.

The increase in refinancing activity was less than expected and activity may be starting to feel the effects of the increase in mortgage rates over the past several weeks. For example, the previous report from the MBA was not adjusted for the Martin Luther King, Jr. holiday.

According to Countrywide Securities analysts, using a half-day adjustment, the Refinance Index would have held steady at 2054 from the previous week. Based on this number, refinancing activity in the latest report would have seen a decline of nearly 6%.

The MBA also reported a slight decline to 47.4% from 47.8% in the refinance share of mortgage activity. ARM share increased to 21.4% from 20.3%.

30-year fixed mortgages increase

After lagging somewhat the increases in interest rates in recent weeks, fixed mortgage rates jumped last week. According to Freddie Mac's latest survey, last week also saw the 30-year fixed mortgage rate increase to 6.34% from 6.25%. This is the highest rates have been since early November when they were at similar levels. Since hitting a low of 6.11% in early December, rates have backed up 23 basis points. A year ago, 30-year mortgage rates averaged 6.23%.

In other loan programs, 15-year fixed mortgage rates rose eight basis points to 6.06%; one-year ARM rates averaged 5.54%, a five basis point gain from the previous week; and lastly, five-year hybrid ARM rates were up four basis points to 6.04%.

Countrywide Securities analysts reported a noticeable slowdown in the firm's application activity on Friday, Jan. 26, in response to increasing mortgage rates. This suggests potential for some slowing in mortgage application activity in this week's MBA report with the higher mortgage rate levels.

Prepayment outlook

Initial expectations for January are for speeds to be little changed overall from December with slight declines anticipated for discounts, while par and premium coupons are predicted to be flat or up less than 5%. Factors influencing speeds include a higher day count - 21 days versus 20 days in December - and lower mortgage rates with the 30-year fixed rate averaging 6.14%, down 10 basis points from November's average. However, refinancing activity was slightly lower on average at 1880 versus 1919 because of the holidays.

There is the potential, however, that speeds could show more slowing than expected, said Merrill Lynch in a research report. They noted that speeds in December were faster than expected which could have been due to loan applications from the first week of December actually closing before the end of the year. So, if December's applications were actually completed in December, they said, January could be an even slower month than originally projected.

The January reports will be out Wednesday, Feb.7. Paydowns are estimated in the low $30 billion area.

Speeds in February are currently projected to slow around 7% on average due to a lower day count (19 days) and weaker seasonals. March speeds are seen jumping 15% to 20% as the number of collection days increases to 22 and seasonals start to strengthen.

(c) 2007 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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