Mortgages saw decent volume in the first half of last week as the Federal Reserve dominated the market's attention. Flows Monday were mixed with heavy selling in the morning. This moved spreads substantially wider, which then drew in buyers in the afternoon. Specifically, originators sold about $2.5 billion in 5.5s and 6s, while servicers were actively moving up in coupon - to the tune of $4 billion, according to sources. The weight of the supply sent spreads wider to swaps by five to six ticks, attracting real money and leveraged buying in the afternoon and decent overnight buying.
The Monday afternoon support carried over into Tuesday's pre-Federal Open Market Committee session with active buying noted from money managers, leveraged investors and servicers - this time moving down in coupon from 6s to 5s. Prior to the Fed's afternoon statement, buyers were outnumbering sellers. After the Fed's disappointing action - just 25 basis points cut in the Fed Funds rate, 25 basis points in the discount rate and no certainty on the bias - spreads surged wider with money managers taking profits as Treasury prices jumped. Specifically, the 10-year Treasury yield fell to 3.99% from 4.149% as of Monday's close.
Mortgage-backed spreads were substantially tighter in Wednesday's morning session, though flows were notably choppy. Treasurys were continuing to sell off as stocks rallied on a new plan announced by the Fed, and the cheapening was drawing in support for MBS. Flows were generally up in coupon. The sharp selloff, however, was not leading to any active selling from the convexity crowd. Talk was that none was expected as prices were still within their recent range given the tightening.
By midday Wednesday, the 10-year Treasury yield was at 4.11%, up from 3.99% at Tuesday's close. Relative to the curve, spreads were nearly 11 ticks tighter in 5s and 5.5s, over seven ticks in 6s and over four ticks in 6.5s. Versus swaps, spreads were firmer by over two ticks in the lower half of the coupon stack and over one tick to flat, respectively, in 6s and 6.5s. Swap spreads were substantially tighter (four basis points in 10-years and six basis points in five-years). Volatility was also sharply lower.
Contributing to the positive tone in MBS was some improvement in rolls resulting from the plan by the Fed to help improve the credit crisis. Along with the Bank of England, the Bank of Canada and the Swiss National Bank, the Federal Reserve said it would take the following actions to help relieve pressures in the short-term funding market. The actions are the establishment of a temporary Term Auction Facility and foreign exchange swap lines with the European Central Bank and the Swiss National Bank.
Through midweek, originator selling was fairly active, averaging between $1.75 and $2 billion per day. Supply was in 5.5s and 6s. Overseas had also been fairly active buyers.
In the first week of December, mortgages lagged behind Treasurys. Lehman Brothers said that the MBS Index is at negative 20 basis points. The various cross-sectors were also trailing Treasurys with the ABS Index at negative 14 basis points, the CMBS at negative 44 basis points and Corporates at negative 49 basis points.
The near-term MBS outlook remains mostly cautious to negative. Countrywide Securities analysts recommended a small underweight to the sector. Specifically, analysts suggested underweighting discount coupons, noting their vulnerability to slower prepayments and the weak housing environment.
Prepayment Outlook
With the improvement in mortgage rates and stronger refinancing activity, prepayment speeds in December are projected to increase. Previous expectations had speeds slowing about 7% to 8% on a lower day count and slower seasonals. However, updated initial estimates have speeds increasing about 2% on average for 4.5s through 6.5s. In November, the 30-year fixed mortgage rate averaged 6.2%, according to Freddie Mac, down 15 basis points from October's average. At the same time, the Refinance Index averaged 2343 in November, up nearly 12% from the previous month.
In general, speeds are expected to increase the most on 2006 vintages for both discount and premium coupons.
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