The story currently in mortgages is the very favorable technicals, low volume, and range bound market. On top of these are: improved rolls, a decline in dealer inventories, and bank interest. According to the New York Federal Reserve, net dealer positions as of April 12 dropped to $12.4 billion from $25.4 billion, and are at levels similar to January and February. The Federal Reserve also reported MBS holdings at large banks rose $16 billion as of the week ending April 12. Year-to-date, MBS holdings at large banks are up $54 billion.
Last week mortgages held up very well despite a strong sell-off on Tuesday and Wednesday that moved the 10-year yield from 4.98% as of Monday's close to 5.10% by Wednesday's close. The above factors, however, contributed to market orderliness and kept mortgage flows two-way. Also contributing to the calmness is the limited hedging needs of servicers at this time as the mortgage market is near full extension.
On Thursday, the market got further confirmation of a continued range bound market and ongoing low volatility from Federal Reserve Chairman Ben Bernanke's comments before the Joint Economic Committee where he hinted that the Fed could pause in June. The market strengthened on his comments and mortgage spreads moved tighter on the better buying, given the outlook.
Street sentiment: Neutral
Mortgage sentiment is generally neutral at this time. For example, Lehman Brothers analysts have a neutral stance on the basis due to the strong technicals. They add that a rally could lead to additional volatility selling and basis outperformance "as more comfort develops around the range trade." Deutsche Bank Securities researchers are also recommending a neutral bias. They believe that the recent performance of mortgages in the back up bodes well as it suggests that market participants are well positioned for a further increase in rates. The researchers said servicers have also been limited sellers despite the move above 5% on the 10-year that suggests they may be well positioned if interest rates back up further.
UBS analysts finally downgraded their recommendation to neutral from modest overweight on concerns about volatility. Volatility is lower than where it should be, according to their model. In addition, spreads are relatively tight heading into a period of key economic releases - including non-farm payrolls. They believe the combination puts mortgages at risk for some underperformance. Give the Federal Reserve's focus on the data, volatility is expected to pick-up around key economic releases.
This week's key events include the Treasury's Refunding Announcement on Wednesday morning and the April Employment report on Friday. Typically, mortgages tend to benefit following the non-farm report as volatility ticks lower. Also supportive for mortgages are the April prepayment reports that are released Thursday evening for conventionals and Friday morning for GNMAs.
Current indications suggest prepayment speeds will decline around 8% to 10% in April, primarily due to a lower day count with the slowing fairly uniform across coupons and vintages. JPMorgan Securities analysts estimate paydowns at $41 billion compared to $42 billion in March.
May speeds are seen picking back up with day count, once again, being a contributing factor. In general, 5.5% coupons and lower are anticipated to increase around 10%, while higher coupons will hold steady to less than 5% higher as they feel the effect of higher mortgage rates. June prepayment speeds should be little changed in 5.5s and higher, and around 5% faster in lower coupons.
Mortgage application activity declines less than expected
Despite the jump over 6.5% on the 30-year fixed mortgage rate, the decline in application activity was less than expected. The Mortgage Bankers Association reported last week that the Purchase Index fell 4.4% to 389, while the Refinance Index was off just 2.4% to 1489. Expectations were for the Refinance Index to fall closer to the 1400 area.
As a percentage of total application activity, refinancings were little changed at 37.1% versus 37.3% the previous week, based on dollar volume. ARM share declined to 40.7% from 42.4%.
Mortgage rates continue
their steady trend upward
Mortgage rates continued their trend upward, according to Freddie Mac's latest survey. For the week ending April 28, the 30-year fixed mortgage rate moved up to 6.58%, a five basis point gain from the previous week. This is the highest since June 20, 2002 when it averaged 6.63%. With an average of 0.5 points, the no-point mortgage rate is around 6.71%.
Meanwhile, 15-year fixed mortgage rates rose four basis points to 6.21%. This is the highest level since May 31, 2002 when it was at 6.22%. In the adjustable rate programs, 5/1 hybrid ARMs rose to 6.21% from 6.16% previously, and one-year ARM rates stand at 5.68% compared to 5.63% last week.
Application activity has held up better than expected as mortgage rates increase. Still, the Refinance Index is predicted to trend towards 1400 in the coming weeks.
"Indications of a stronger economy gave rise to an increase in mortgage rates this week," Freddie Mac Chief Economist Frank Nothaft said on Thursday last week. He noted that consumer confidence and existing home sales unexpectedly increased, attributing much of the positive indicators to a healthy labor market that translated into more consumer spending. "This should support an active housing market over the next few months," he said.
Nothaft added that Freddie Mac expects mortgage rates to gradually increase throughout 2006. "A stronger labor market, coupled with moderation in house price growth, means our outlook for overall housing conditions remains upbeat," Nothaft said.
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