Quantitative easing got a shot in the arm this week as the Federal Open Market Committee (FOMC) minutes from the July 31-Aug. 1 meeting released Wednesday afternoon revealed stronger support for the move.
It might have also indicated a lower bar for implementation than the statement had suggested as "many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery".
Odds which had been at about 80% before the stronger-than-expected July employment report dropped it to 50%. iAfterwards, it then jumped back up to the 70% area.
The strengthened QE odds drew in a wide range of investor participation including hedge funds, REITs, money managers, banks, and overseas buyers. The interest was specifically focused along 3.5s through 4.5s.
The Federal Reserve remained focused in 30-year 3.0s and 3.5s at a daily average pace of $1.3 billion, while originators bought back hedges in these coupons following the strong rally.
However, by Thursday afternoon and continuing into Friday flows were more two-way in 3.0s and 3.5s following outperformance as these coupons repriced the QE expectations. Meanwhile, originator selling picked up as the decline in rates led to a pickup in rate locks. Buying interest also moved up in coupon as high as the super premiums with the mid-week cheapening.
At this point, it appears investors are again opportunistically sensitive to price and yield levels along the lower stack and so should trade in a narrow range until more information on the economy or from the Fed is available.
This coming week does include several important economic barometers such as the second reading on second quarter GDP, Chicago PMI and Consumer Confidence and Sentiment numbers as well as the Fed's Beige Book. How much any weak readings lead the market to infer asset purchases are imminent is not readily clear. However, response is expected to be tempered as investors wait for the week's highlight: Fed Chairman Ben Bernanke's address in Jackson Hole, Wyoming in the morning of Aug. 31 on monetary policy since the crisis.
Currently, many expect the FOMC to extend the low fed funds rate outlook from late 2014 to late 2015 at its Sept.12-13 meeting based on the remark included in the minutes "that such an extension might be particularly effective if done in conjunction with a statement indicating that a highly accommodative stance of monetary policy was likely to be maintained even as the recovery progressed."
As for asset purchases with MBS, the thinking is that it is not a matter of if, but when as "many participants expected that such a program could provide additional support for the economic recovery both by putting downward pressure on longer-term interest rates and by contributing to easier financial conditions more broadly." With the presidential election in November, however, these are expected to happen afterwards.
Still, the prospects of just the extension of the low-rate guidance provides a supportive tone for MBS in terms of carry and vol, along with demand technicals as it bodes especially well for more capital raising and buying from REITs.
For instance, in a report earlier this month from Nomura Securities, analysts stated that the Fed staying on hold for a lengthy time frame presents a great opportunity to the REIT business model.
They added that if the Fed were to indicate that they will remain on hold for an additional 1.0-1.5 years, REIT demand for MBS can increase more and offset the net supply of agency MBS from the GSEs and overseas investors to the rest of the market. Addtionally, "even in the absence of the Fed growing its agency MBS holdings and banks not being as active as before in the MBS market," Nomura said.
So far this year, REITs have been the marginal buyer after the Fed with MBS purchases totaling over $60 billion.
In other mortgage activity, 15s lagged 30s as a result of the curve flattening around 12 basis points (2s10s) over the week, while GN/FNs were mostly higher in response to overseas buying in GNMAs.
Activity in specifieds picked up on the back of the FOMC minutes with demand reappearing for call protected paper, while BWICs increased with payups starting to recover after weakening in response to the sharp sell-off in August.
If it wasn't for the FOMC minutes, volume likely would have been even lower than its average through Thursday of 90% as the summer doldrums tend to be at their peak in the last half of August.
Mortgage banker supply averaged a very manageable $1.9 billion per day compared to $2.3 billion last week. Excess return to Treasurys on the Barclays MBS Index totaled eight basis points that brought the month-to-date outperformance to +18 basis points.
In another measure, the 30-year current coupon yield dropped 18 basis points to 2.50% with the spread to 10-year notes four basis points tighter to +83.