Despite light trading and a short-term interest rate increase by the Federal Open Market Committee, the overall tone of the mortgage market has been positive, say investors and researchers.
"Having the Fed behind us as a player in the market for at least a few months should make it a more attractive environment for mortgages," said Greg Rosenberg, a mortgage-backed securities trader at J.P. Morgan. "In fact, we've moved to an overweight recommendation in mortgages."
"The Fed action was essentially good news for the mortgage market," added Dale Westhoff, MBS researcher at Bear, Stearns & Co. "The market took it as it's going to give us some inflation protection. There's not likely going to be a rate increase in the near future.'"
Others see the increase as positively affecting the spread product. "In general, people are starting to realize the value of mortgage in this relatively range-bound environment after the Fed decision to tighten," said David Montano, a director of research at Credit Suisse First Boston. "Belief that the Fed is not going to act at least the rest of the year means that you're in a pretty stable environment and therefore people want to collect the spread on mortgages."
John Carson, head MBS trader at Morgan Keegan, added, "Spreads have tightened across the board. We saw swap spreads break through 80, and the like, so I feel the market is not trading particularly well, but it also doesn't feel like it's breaking away badly."
Despite relatively low trading volume, activity has been unusually high for this time of year. "We've seen banks back in the market for the first time in what seems like an awfully long time, and it's performed extremely well," said Carson. "It's been a pretty much across-the-board return after several months of very low volume trading."
Westhoff agreed. "What we're noticing is it's been relatively thin trading, but even thin trading is moving the markets quite a bit," said Westhoff. "Since August spreads are tighter by about 40 basis points, we've really come in even with this factor of Y2K and the liquidity constraints that that imposes on the market."
He added that even in the less liquid non-agency sector, spreads have come in about 50 basis points, and added that as little as six months ago, investors would not have predicted the market to perform this well.
Discounts Outperform Premiums
"Discounts in general have done well in part because a lot of investors are nervous about prepayment risk, and confident about spread tightening, because you have relatively little prepayment risk and you have a lot of spread exposure," said Montano. While saying this, though, he noted that seasoned discounts are outperforming to-be-announced pools, but due to a low supply of seasoned TBAs, the discounts are not viewed as a good investment.
"There has been some up in coupon," noted Westhoff. "The passthrough sector is pretty fair versus agencies and swaps, and probably has more value going up in coupon."
Montano also hinted that the refi wave isn't quite over just yet, implying that Fannie Mae 7.5s are the most attractive, being slightly above par dollar price, while the 8s are the most rich. "It's an indication that the market is still extremely refinancible," he noted.
There are four trading weeks left in 1999, and Montano expects the last two to be fairly quiet.