Market flows were light and went in both directions as last week got started, while many participants held out for the Federal Open Market Committee's statement on Wednesday. The tone in the mortgage-backed sector, however, was supportive with overseas investors, hedge funds, money managers and servicers buying in 5s and 6s, both outright and against Treasurys and swaps. Specified pools were also seeing interest, particularly from money managers focused in the 5s and 5.5s, while fixed 10/20 paper was getting bids from CMO desks and real money.
Flows were picking up Tuesday as data raised the possibility that the Federal Reserve would cut its rate next time by only 25 basis points, instead of by the 50 basis points the market had been expecting. Following the better-than-expected durable goods news, fed funds futures put odds of a 50-basis-point cut at 76%, versus 84% ahead of the report. As of midday last Tuesday, Treasurys were selling off, with the strong data as well as the Fed's and government's actions suggesting that a recession was less likely. The 10-year Treasury yield was at 3.694% compared with 3.584% as of the previous Friday's close. Mortgages initially were tighter on real- and fast-money buying as well as because of overseas investor interest. However, these had weakened by midday as supply and profit-taking picked up.
Before the ADP employment report and initial claims were released, the consensus put nonfarm payrolls at 58,000 and the unemployment rate at 4.9%. Deutsche Bank Chief U.S. Economist Joseph LaVorgna said, however, that the January report could be surprisingly high because of recent initial unemployment claims reports. Lately, however, the data has not been such a good predictor, LaVorgna noted. His preference was to use the ADP employment report as opposed to initial claims, which he estimated would show a 45,000 job increase for January. If the ADP report were significantly higher than estimates, economists would likely make upward revisions to their employment forecasts.
Street estimates for prepayment speeds have been revised higher, with dramatic increases predicted for February and March because refinancing activity has been picking up in response to the sharp drop in mortgage rates. The speeds are projected to increase about 3% overall in 4.5s through 6.5s in January, with the greatest gains in the 2006 and 2007 vintages. For example, 2007s are projected to be 16% higher than they were in December, while 2006s are expected to be up around 5% to 7%. Other coupons and vintages are expected to be about 1% to 2% slower on average.
Speeds are expected to surge in February by 37% in FNMAs, and will be led by 2007 vintages, expected to be up 50% on average. The 2006 vintage is expected to average 42% higher, while the remainder of the coupons and vintages are projected to increase 33% from January's levels. GNMAs are expected to increase about 20% overall, with 2007 and 2006 vintages gaining 33% and 29%, respectively, while other vintages are estimated to be up by 14%.
In terms of March prepayments, speeds on both FNMAs and GNMAs are currently expected to have further increases of 30% from February.
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