The new year got off to a good start for mortgages. Minutes from the Federal Open Market Committee's December meeting suggest that they are nearing the end of their tightening cycle. The market rallied on this news, and moved the 2s/10s spread back into positive territory from flat to slightly inverted at year-end. This encouraged real and fast money, servicers and dealers to become active buyers. The re-steepening of the curve also led investors up in coupon into mostly 5.5s and 6s in 30s. Meanwhile, 15s also saw strong support with an up in coupon preference as well. Originator selling picked up as the week progressed and by later in the week, activity was near its $1 billion per day average. Supply has been concentrated in 5.5% coupons.
The near term outlook suggests better buying should continue for the next few days after which better profit taking could enter the picture. Traditionally, the sector benefits from the drop in vol following the employment report. Also, Monday should see reinvestment of December paydowns. JPMorgan Securities is currently estimating paydowns to be around $41 billion.
In research last week, UBS analysts stated that mortgages looked fundamentally cheap on their model. In addition, they see technicals as balanced with the net positive fixed-rate supply getting absorbed by overseas investors. Based on the above, UBS is maintaining a modest overweight in MBS.
Refi Index gains in holiday period
The Mortgage Bankers Association reported a 1.5% decline in mortgage application activity for the week ending Dec. 30. Activity was boosted by a seasonally adjusted 8% increase in refinancing activity to 1363 from its lowest level since April 2002 - 1259. Purchase activity, meanwhile, slid 3% to 418. As a percentage of total application activity, refinancings rose to 42.7% from 40.2% in the previous week. ARM share fell to 28.8% from 32.5%.
In the first week of the new year, mortgage rates held little changed from last week, according to Freddie Mac's weekly survey. For the week ending Jan. 6, the 30-year fixed rate average 6.21%, down from 6.22% last week. In other programs, 15-year fixed rates were unchanged at 5.76%; 5/1 hybrid ARM rates were down one basis point to 5.78%; and one-year ARM rates rose one basis point to 5.16%.
With the modest decline in mortgage rates over the past several weeks and the holidays past, expectations are for refinancing activity to increase towards 1500 in the next couple of weeks.
Looking back over 2005, 30-year mortgage rates averaged 5.87%, little changed from 2004's average of 5.84%. In 2006, expectations are for the 30-year rate to average 6.44%. Meanwhile, 15-year fixed mortgage rates recording a larger increase averaging 5.42% versus 5.21% in the previous year. One-year ARM rates recorded the highest year-over-year gains due to the Fed rate hikes, averaging 4.49% in 2005 compared to 3.90% in 2004. Despite the flattening of the curve and large increase in short rates, ARM activity is expected to remain relatively strong at around 30% in 2006, down just slightly from 2005 levels.
Prepayment outlook
The December prepayment reports were out Friday, after ASR went to press. Speeds were expected to slow another 10% to12% on average from November's level in response to a sharp increase in mortgage rates and a decline in refinancing activity in recent months. For example, in November the 30-year fixed rate mortgage rate averaged 6.33% compared to 6.07% in October, according to Freddie Mac. Over the same period, the MBA's Refinance Index averaged around 1633 in November, declining from an average of 1970 in October.
For 2005, prepayments were relatively stable, though elevated, with speeds peaking in July and August as declines in mortgage rates in late June/early July provided one more attractive opportunity for the housing market. The year is expected to close out with speeds on 2003 vintage 5.5s and higher prepaying at their slowest level of the year. Meanwhile, 2004 5.5s and lower coupons are predicted to hold modestly higher than their slowest levels observed at the start of 2005.
Peering into early 2006, speeds are expected to slow even further in January and February, before starting to trend higher as the spring season brings increased activity. Still by May, Bear Stearns predicts speeds will be only similar to what consensus is predicting for December.
The refinance incentive has deteriorated significantly with only around 10% of borrowers having an incentive. This is looking to slip further if mortgage rates rise as is expected. Currently, the 30-year fixed mortgage rate is anticipated to average 6.44% in 2006, up 55 basis points from 2005's average.
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