The recent easing of the squeeze in 30-year FNMA and Gold 5s has removed some of the pricing and liquidity concerns in the market.
"What is easing the squeeze in 5s is that there has been significant new origination in the coupon, helped by slightly stronger refinancing activity and healthy seasonal factors," said Paul Jacob, a mortgage strategist at Countrywide Securities. He explained that originators have reacted to the coupon run-up by pooling most of the new production as 5s.
"Supply has come to the rescue, which we felt would eventually happen, the only question mark was how long that would take. Would it be a matter of weeks or a matter of months?" he said.
Jacob added that the squeeze in the 5% coupon, combined with similar technical factors in the MBS market, has increased some awareness with investors while also raising their risk profile. "They are probably looking over their shoulders because the potential for another squeeze is always there," Jacob said.
Other analysts said that the market's concerns about collateral recycling have been removed as well. "Broadly, liquidity concerns have been alleviated," said Mahesh Swaminathan, mortgage strategist at Credit Suisse First Boston. During the height of the squeeze, Swaminathan said that, "there was a perception that there were only one or two coupons to play with as everything was connected to FNMA 5s, closing off quite a bit of the 30-year market as it was entirely technically driven."
Although the float in the coupon is still somewhat constrained, the positive is that the FNMA 5s were taken out due to "real" demand for 30-year 5s as opposed to merely being recycled from newly created Mega pools, as evidenced by the Fannie Mae Mega collateral report released recently. "This allays the concern in the market that the megas in the coupon were not really being put away, but just being recycled as a tactic to prop interest in the coupon," said Swaminathan.
The Fannie report showed that three large Mega pools (numbers 735676, 735667, 735669) were created in June, accounting for $25.5 billion in FNMA 5 Mega issuance for the month. These pools contained merely $257 million - equivalent to 1% - in Megas issued January to May. Further showing "real" demand is the fact that older collateral was used for these recently created Megas. For instance, 64% of the included balance was sourced from 2003 or 2004 pools. Fannie Mae also reported that $7.2 billion of FNMA 5 Megas were new pools issued in June, adding that of the $2.2 billion that January to May 2005 pools contributed, roughly 90% were made up of individual pools rather than Megas.
The easing of the short in the 5% coupon, however, does not change the technical dynamics since there are no current indications of excess supply in 5s that would cause the coupon to underperform, Swaminathan said. For instance, in July, approximately $17 billion of FNMA and $15 billion of Gold 5s are expected - not a significant amount. Furthermore, if 10-year Treasury yields stay at current levels, a considerable increase in 5% coupon creation should not be expected for August and September.
In its mid-week report, JPMorgan Securities said the FNMA roll had been drifting lower for the last couple of weeks, taking a huge plunge on Tuesday with heavy servicer selling of the roll that overwhelmed origination activity for September. Analysts said that this makes it apparent that the Street is no longer short the FNMA 5 roll. "Even with relatively heavy origination volumes, the front month roll dropped by over a tick," analysts wrote. Analysts stated that they expect a firmer bounce as fast money monetizes gains, adding that in the current risk-averse environment, profit-taking as well as loss stoppages are prevalent.
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