With Federal Reserve Chairman Alan Greenspan's Congressional testimony yielding nothing especially new, it appeared that last week would turn out to be a yawn. China, of course, changed that. The China headline news - regarding pegging its currency to a basket of currencies rather than just the U.S. dollar - jolted the market on fears that the change will lead to reduced Chinese investment in U.S. dollar assets. Before this, the mortgage tone had been supportive with focus on moving up in coupon, particularly into 30-year 5.5s by servicers and hedge funds, and into 6s by relative value investors. On Thursday morning, as the China revaluation news was reported, mortgages experienced strong selling from originators and fast money especially in 4.5s through 5.5s - over $3 billion combined as of mid-day.
Analysts last week were mostly neutral to positive on the mortgage sector given current yield levels and expectations of a decline in volatility, with preference to move up in coupon while further spread tightening is anticipated to be limited. The longer-term outlook is less certain. On the supply side, JPMorgan Securities estimates 30-year agency MBS is on track to increase its market share by $100 billion per year. At this pace, analysts say the 30-year sector will be almost evenly distributed across 2003, 2004 and 2005 originations. At the same time, 15-year issuance is looking to drop by $60 billion per year. While supply is increasing in 30s, decreasing demand is a concern. Bank support has been concentrated, the GSEs' outlook is very limited, and overseas buying has been less supportive than anticipated as a result of the tight spreads in the sector.