It has been a pretty "wild" week for mortgages, market players say, as Wall Street decided to hold off on buying and therefore produced low prices on bonds.
"The market rallied significantly and mortgages performed well near the end of the week, keeping in line with the rally of the 10-year," said David Montano, a director of mortgage research at Credit Suisse First Boston. "Swap spreads also came in, as well as volatility, which has been decreasing for many weeks now."
On the week, mortgages were slightly down, with premium 7.5s and 8s being the worst performers. Discounts did a little bit better. Additionally, 15-year fixed-rate MBS did better on the week than 30-year paper.
"This is a little bit surprising," added Montano, "considering that volatility is continuing to decline. There is a divergence between where the market is pricing volatility and the kind of interest rate movements that we are seeing."
The actual daily volatility that is being observed is higher than where the market is pricing it, so it is "a little bit uncomfortable," Montano says. "It's just not clear to the market now where volatility is actually at."
One sector that has been recommended by players this week was discounts, and one trader mentioned that 30-year 7.5s seemed to be one of the cheapest coupons, relatively speaking.
"The discount sector is one of the few sectors where we see fairly decent pay-ups for seasoned collateral," said the trader. "That paper looks very attractive as compared to TBA, which rolls flat and slightly below carry, and it doesn't finance well. The seasoned paper looks attractive to the TBA and has a half-a-tick a month of extra carry, which makes it look attractive for us."
Overall, however, the mortgage market seemed to be pricing things fairly efficiently, with nothing really sticking out, sources say.
"Mortgages narrowed substantially this past week, but most of the focus this week has been on the corporate market," said Rick Zackroff, who manages $700 million in fixed-income assets at Pennsylvania-based PMG Advisors. "Corporate spreads have done very well over the last week, which is taking some attention away from mortgages, which obviously outperformed corporates the week before."
Zackroff said that supply has basically been met by demand, and mortgages have held gains for the most part.
"September has been an excellent month for mortgages, with some good spread tightening", added Montano. "The mortgage spreads are pretty much at their one-month average, so there hasn't been any tightening in OAS', but volatility has declined, and therefore mortgages have done well."
The most talked-about topic on the Street last week was certainly FASB's recent ruling regarding synthetic call-put structures. These structures, issued mostly in 1998, were corporate bonds which, at a fixed point in time, have a call option. The underwriter keeps the call and the bond holder keeps the put, so the paper becomes a bullet bond for the bond holder. The structure tends to lower the financing for corporations, and was one of the principal causes for the decline in volatility last year.
When FASB and the SEC started looking at it in late 1998, they started requiring corporations to market these options they were selling, and that punctured the bubble in this product. Just recently, FASB decided that they are not going to make this a requirement any longer.
"This puts more pressure on volatility to decline, since the market is coming back," said Montano. "This is yet another factor helping spreads tighten for mortgages."
