It was an Olympic week in the markets this week with three top tier events: Federal Open Market Committee (FOMC), European Central Bank (ECB) and July employment.
Expectations were particularly high regarding the first two events with the FOMC expected to extend its forward rate guidance from late 2014 to late 2015, and the ECB making good on last week's remarks from Mario Draghi to "do whatever it takes."
Meanwhile, nonfarm payrolls for July was anticipated to show only minor gains from June and thus strengthen the case for QE3 in September.
The results: the FOMC and ECB were all talk with no changes to monetary policy while the employment news did not remove QE3 off the table. Two main sources of risk to the economy that Chairman Ben Bernanke highlighted in his recent testimony to Congress remain the euro-area fiscal and banking crisis and the U.S. fiscal cliff.
Regarding the central bank results, the FOMC's statement did suggest it was moving closer to additional accommodation as the statement reported economic activity appeared to have "decelerated" somewhat over the first half of the year compared to "expanding moderately this year" in the June report.
The Committee also said it "will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability." This appeared to be a more aggressive remark than previous which read "The Committee is prepared to take further action as appropriate." Meanwhile, the ECB said it was working on plans to help the euro zone.
Nonfarm payrolls was much stronger than expected at +163k in jobs created versus an expectation of +100k; however, the unemployment rate ticked up to 8.3% from 8.2%. Despite the strength of the jobs report, economists with Deutsche Bank Securities said that it actually will be the August employment report that really matters for monetary policy decision-making, and they expect to see improvement based on the recent declines in initial claims.
As a result, they believe the Fed will only extend its forward rate guidance to late 2015 from 2014 when it next meets in September.
Ultimately it continues to be a wait and see environment and so the mortgage trade should remain range bound with investors remaining opportunistic and reactive to data. Technicals remain favorable with the Fed reinvesting its paydowns, while steady capital-raising from REITs keeps them as the marginal investor after the government.
For this past week, flows were active and two-way amongst real and fast money with Tradeweb volume at a 108% average through Thursday as the 10-year note yield ranged between 1.486% as risk off took the upper hand on disappointment over the ECB inaction into the mid/upper-1.50s as the market sold off after both the FOMC failed to deliver and on the better than expected payrolls print.
Of particular note was a pickup in mortgage banker supply which averaged $2.6 billion per day versus $1.8 billion last week, consisting largely of 30-year 3.0% coupons and to a smaller extent 3.5s. Meanwhile, the Fed's daily average buying remained at a $1.3 billion pace indicating supply coverage of just around the 50% area.
While lower coupons struggled with supply, higher coupons benefited from increased interest on favorable prepayment expectations, as well as, a steeper yield curve. July prepayments will be out late Monday afternoon and HARP-eligible 30-year 5.5s through 6.5s are seen increasing a modest 1-2%, while 2010 and 2011 3.5% and 4.0% coupons anticipate increases at between 25% and 35% as borrowers responded to record low mortgage rates.
In other activity, 15s outperformed 30s, while GNMA/FNMAs were little changed to slightly higher on 4.0% coupons and lower, while the decline in MIPs for streamlined refis for pre-June 2009 borrowers along with Bank of America delinquency buyouts continued to hurt 4.5s and higher. In specifieds, originator cycle BWICs picked up with Class A pool allocations next Thursday, while demand from banks, REITs, and CMO desks for call protected paper remained strong.
Excess return to Treasuries on Barclays' MBS Index Monday through Thursday was -3 basis points. For the month of July, mortgages outperformed Treasuries at +28 basis points. So far in August, the index is lagging by two basis points. The 30-year current coupon yield was two basis points lower from last Friday at 2.42% (2.50s as proxy) with the spread to 10-year notes unchanged at +88.
Announcements from FHFA
In the midst of this week's events, quite unexpectedly and briefly taking the spotlight, Federal Housing Finance Administration (FHFA) Acting Director Edward DeMarco released a letter he had sent to Senators Johnson and Shelby saying that it would not implement principal forgiveness provided through the Home Affordable Modification Program Reduction Alternative (HAMP PRA) as the risks and costs to taxpayers outweigh the benefits.
The letter also went on to discuss some changes that should help certain borrowers refinance. For instance, Freddie Mac would be aligning its policies with those of Fannie Mae for mortgages with LTVs less than or equal to 80%. This "will eliminate many of the lender's selling representation and warranty responsibilities on the original loans being refinanced, regardless of the borrower's loan-to-value ratio," said a Freddie Mac press release. Details are scheduled to be announced to lenders by mid-September. Only a limited impact is seen regarding prepayments as many of these borrowers have not faced the refi hurdles that higher LTV ones have.
DeMarco noted as well that based on feedback from lenders regarding the HARP 2.0 changes, "a few operational adjustments to further simplify this process and increase the number of loans approved for refinancing" had been identified and updated guidance was forthcoming.
Also discussed were new requirements on reps and warrants that were being developed by the GSEs that should provide better guidance for lenders and reduce putback risks. Issuance of these standards is expected in September. The general thought here is that it might loosen up the extremely tight credit standards a bit, as well as, lead to increased competition as smaller originators may become more active.
To help further reduce GSEs risk, the FHFA said it would be announcing by the end of August "another set of gradual adjustments in guarantee fee pricing that will take effect later in the year." While lower coupon borrowers would be most impacted by this as it would increase their cost of refinancing, prepayment risk for investors would be lowered. Barclays cautioned, however, that lenders would likely ramp up loan closings before the rate hike which would lead to a temporary spike in prepays.
The FHFA at least was clear on what is coming and when, and what it's not going to do.