This week came alive on Wednesday as investors responded to the re-election of President Barrack Obama as well as the October prepayment reports that were released late afternoon on Tuesday. It was a rough day for mortgages with Barclays MBS Index underperforming Treasurys by 22 basis points and the 30-year current coupon spread widening five basis points to +60 – its widest level since QE3 was implemented in mid-September.
With the status quo maintained in government, Treasurys rallied sharply with 10-year notes surging nearly 1 point as focus immediately shifted to the fiscal cliff issue with the expectation that it will not be resolved before the end of the year.
In mortgages, buying in 30-year 3.0s and 2.50s surged as money managers, hedge funds, overseas investors, and the street perceived continuation of easy monetary policy, i.e., QE3, beyond Federal Resesrve Chairman Ben Bernanke's term expiring in January 2014.
Meanwhile, higher coupons had two strikes against them between faster than anticipated speeds and renewed refi.gov fears. CPRs on the Home Affordable Refinance Program (HARP) cohorts (2006-2008 vintages) surged 15% to 20% versus a projected 10%. A significant influence, however, was a pronounced increase in speeds on Bank of America-serviced loans – particularly in its Countrywide portfolio. There were some changes made in September to HARP 2.0 which could have contributed to the larger than predicted increase in speeds in October beyond the higher number of collection days, according to Barclays research. They went on to warn that this latest report "seems to signal a paradigm shift for Bank of America pre-HARP speeds."
Meanwhile, also worrisome to the up-in-coupon trade were fears that the president would replace acting Federal Housing Finance Agency Director Edward DeMarco with someone more amenable to significantly reducing refi frictions for credit-impaired borrowers – including the use of principal forgiveness.
Risk-off held sway over the remainder of the week with domestic and global equity markets plunging on the adverse impact to the economy if the fiscal cliff issue is not addressed with the 10-year note yield lower by about 10 basis points from 1.726% as of last week.
Flows across the stack were mixed with bouts of profit-taking down-in-coupon leading to opportunistic buying on price or spread weakness, while higher coupons remained mostly pressured on the increased refinancing risk; although real money ventured a bit into up in coupon, particularly 4.0% and 4.5% coupons, on the cheapening.
The Fed, of course, remained a steady buyer. The New York Federal Reserve Bank reported gross purchases of $20.35 billion and net purchases of $19.15 billion in the week ending November 7. This equated to a daily pace of $3.8 billion net which was more than a match for the $2.8 billion per day average from mortgage bankers this week. Their purchases were elevated to make up for last week's Tuesday market close due to the superstorm Sandy.
The demand technicals from the Fed look to get a boost in the mid-November to mid-December period from increased prepayments in the Fed's MBS portfolio in October. Combined MBS and agency debenture paydowns are estimated at close to $36 billion, and with their monthly $40 billion in QE3 purchases, comes to $76 billion. This suggests daily average buying at $3.8 billion per day compared to about $3.4 billion in the most recent period. It also compares favorably against daily average mortgage banker supply that has been running at around $3.0 billion recently.
In other mortgage-related activity, it was an active week in specified pool trading with over $15 billion in originator cycle BWICs. Despite the supply, payups held firm on strong demand for call protected paper.
Dollar rolls were mostly pressured into Friday's Class A (30-year FNMA/FHLMC) 48-hour day with fast money selling the Nov/Dec roll, while money managers and servicers rolled early in the week; the exception was the FNMA 5 roll which gained 4/32nds. 15s lagged 30s in part on a flatter yield curve, while GNMA/FNMAs were lower (except for 3.0s) with higher coupons adversely impacted on faster than projected prepayments. Regarding GNMA, delinquency buyouts from BofA was an influence on speeds, particularly in 30-year 5s. In addition to that, other factors especially in the lower portion of the coupon stack were the record low mortgage rate levels, and for pre-June 2009 borrowers the reduction in upfront and annual mortgage insurance premiums.
The week's events led to more normal volume with Tradeweb averaging 107% through Thursday compared to less than 75% last week which was impacted by the superstorm Sandy.
October Prepayment Recap
Conventional speeds increased more than projected in October due primarily to much stronger HARP-related activity than was expected – particularly from BofA. The 30-year FNMA speeds were predicted to increase 10% to 15% on 3.5s and 4.0s and by around 10% on higher coupons. However, CPRs were up between 3% and 8% on average on the lower coupons and by 15% to 20% on the upper ones. The trend was similar in FHLMC Golds as well. The 30-year Ginnies also were faster than expected at 10% to 15% higher versus an expectation of between 6% and 8% on average.
