Mortgages continue to lag in May with month-to-date excess return through May 17 of -16 basis points, according to analysts at Lehman Brothers. This more than wipes out April's gain of 14 basis points. Year-to-date, however, excess return versus Treasurys is still a respectable 42 basis points.
The market tone was supportive in the first part of last week as recent weakness and a modest rally attracted strong buying from domestic accounts with interest ranging from 5s through 6.5s. The tone deteriorated on Wednesday following the stronger-than-expected CPI report that reduced the odds that the Federal Reserve would pause in June. The market sold off sharply and mortgages deteriorated on the uptick in volatility, emerging fears about extension risk, and some profit taking.
With this backdrop, investors are expected to be more cautious and conscious of inflation-related information from various markets, despite the very favorable technicals and attractive yield levels. In fact, through mid-day on Thursday, mortgage spreads were holding in a narrow +/- 0.50 basis point range even as the market rallied strongly - in part due to unwinding of hedges related to corporate and CMBS pricings. Investors were relatively quiet, with slightly better selling reported.
Throughout the week, originator selling remained below the $1 billion per day average. Supply was made up largely of 6% coupons, which has slightly weighed on that coupon.
Also of note was the continued absence of Asian investors. While Asian purchasing activity has been disappointing, it has not been totally absent. According to JPMorgan Securities analysts, it seems that Asian sponsorship lately has "essentially materialized as a reallocation within the mortgage market rather than a net purchase." Analysts expect this is due to an implementation of a rate view rather than on a relative value opinion. Of note, however, is that Asian investors appear to be broadening their buying among the array of mortgage products. Going forward, JPMorgan expects Asian demand to include more ARM products as well as lower credits. Meanwhile, Alec Crawford, managing director and head of agency MBS strategy at RBS Greenwich Capital, believes that full-year purchases in 2006 will rival last year's record. He noted the latest TIC data revealed non-domestic investors purchased $77 billion in MBS and agencies - which were mostly in MBS - in the first quarter compared to $225 billion for all of 2005.
While there was concern expressed by some analysts about the lack of Asian support, there seemed to be an attempt last week to refocus more attention on the domestic bank support seen this year. Demand from banks has been much better than many were anticipating at the start of the year.
In addition to good deposit and asset growth, lending demand, on net, has been steady in commercial and industrial as well as commercial real estate loans and lower in residential mortgage and consumer loans, according to the latest Senior Loan Officer Survey (see story p.19)
Analyst sentiment remains mostly neutral over the near term. On the negative side is the continued absence of Asian investing, heavy dealer inventories, and a potential uptick in volatility. Also, while GSE portfolios have stabilized, Lehman analysts believe valuations need to widen about 10 to 15 basis points to see stronger demand from the agencies. Positives for the mortgage market include the very favorable technicals, unlikely large scale selling from banks, given their unrealized losses and high yield levels.
The Mortgage Bankers Association reported a modest gain of nearly 5% in application activity for the week ending May 12. The Purchase Index rose 2.4% to 426.7, while the Refinance Index jumped 8.4% to 1546.8 - nearly making up for the previous week's decline. As a percentage of total application activity, refinancings were slightly higher at 36.6% based on dollar volume versus 35.3%. Meanwhile, ARM share rose to 43.6% from 41.80%. Based on the number of loans, refinancing share was 35.0% versus 33.8% previously; and ARM share was 29.9% versus 28.5%.
In midweek research from JPMorgan, analysts said there is evidence that the strength in refinancings is due to strong ARM refinancing activity. They note the percentage of ARMs in mortgage application activity rose to 30% in the latest survey, up from 28.5%. The average over the past year has been 30%, despite the curve's flattening. Analysts say the strong home price gains have spurred ongoing strength in affordability products, which has helped keep the total market share of ARMs fairly constant.
rate hits 6.60%
Freddie Mac reported slight increases in mortgage rates for the week ending May 19. The 30-year fixed mortgage rate rose two basis points to 6.60% which is the highest it's been since 6.63% on June 20, 2002. Mortgage rates are up 89 basis points from a year ago.
Freddie's survey also reported a three basis point increase in 15-year fixed rates to 6.20%; a basis point gain to 6.23% in 5/1 hybrids; and no change in one-year ARM rates, leaving the rate at 5.62%.
With higher mortgage rates this week, Lehman believes the Refinance Index will likely retrace some or more of last week's gains. Still, noise is likely to continue in refinancing activity as borrowers refinance ARM loans that are resetting, and on cash-out refinancings so homeowners could consolidate other loans with higher interest rates.
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