Since Federal Reserve Chairman Ben Bernanke spoke in mid-July to Congress, mortgages have performed very well on expectations that the Fed would likely pause in August. Further supporting this view was economic data that provided the Federal Open Market Committee with an opportunity to pause. The FOMC did not disappoint last week, holding the Fed Funds rate unchanged at 5.25%, with a statement that attempted to assuage any market concerns regarding the Federal Reserve's intention to remain vigilant in regards to inflation.
Lehman Brothers said that the MBS Index outperformed Treasurys in July by 20 basis points, and through Aug. 9, mortgages are up by another 18 basis points. Year-to-date, mortgages are up 70 basis points versus Treasurys.
The strong gains encouraged active profit taking as the week started off; however, it turned to strong buying following the FOMC's statement on Tuesday and into midday Wednesday. In general, buying was focused up-in-coupon, and came from a wide range of real and fast money. Asian investors, who have been more supportive lately, were relatively quiet as they waited for the Treasury Refunding to conclude.
While there was better buying overall, profit taking from fast money was seen emerging late Wednesday. In early trading on Thursday, spreads were slightly weaker as the market absorbed news about the uncovering of an attempted terrorist plot to blow up planes leaving the U.K. and headed to the U.S.
The near-term outlook is positive for the mortgage sector, and analysts are neutral to overweight on the sector. Of particular note are the very favorable technicals. Good demand is anticipated from overseas and banks, while supply is expected to remain uneventful. Last week, originator selling held to $1 billion and less per day. Other positives include low volatility, low prepayment and extension risks, as well as attractive yield levels.
MBA reports increase
in mortgage applications
As expected, application activity rose in response to the recent decline in mortgage rates. The Mortgage Bankers Association reported that the Refinance Index rose 7.1% to 1518.1 for the week ending Aug. 4. The last time the index was above 1500 was the week ending May 12, when it was at 1547. After three weeks of declines to its lowest level since Nov. 2003, the Purchase Index rose 3.4% to 388.9. Overall, application activity was up 5%.
As a percentage of total application activity by dollar volume, refinancings rose to 41.3% from 39.7%. This is the first time since mid-February that dollar volume has been above 40%. ARM share was little changed at 41.8% versus 41.6% previously.
30-year mortgage rates down
Mortgage rates declined for the third week in a row, said Freddie Mac. The dip was fueled by the recent employment report and last week's FOMC pause. Freddie Mac's Chief Economist Frank Nothaft noted, "Interest rates for fixed-rate mortgages have dropped to levels last seen in the spring of this year." He also suggested that the decline in rates could encourage an increase in refi activity as borrowers with ARM loans nearing resets switch to fixed rate loans.
According to Freddie Mac's survey, 30-year fixed mortgage rates fell eight basis points to 6.55%. Since a high of 6.80% hit the week ending July 21, mortgage rates have dropped 25 basis points. Rates were last this low in mid-April.
The 15-year fixed rates averaged 6.20%, down from 6.27% last week while 15-year rates are down 21 basis points from July 21. The 5/1 hybrid ARMs slipped six basis points to 6.21%, and are down 15 basis points since mid-July. Meanwhile, one-year ARM rates were unchanged at 5.69%; however, they've fallen 11 basis points in the last few weeks.
With the recent rally, there has actually been some talk about refinance risk. UBS discussed this in recent research, noting that currently about 9% of the market is marginally refinanceable, with 4% fully refinanceable. To get to levels seen in most previous refinance events, Treasury and mortgage rates would have to rally a minimum in the 100 basis points area, they said, and to get to levels seen in June 2003, closer to 200 basis points. With the market "deep into a purchase environment, it suggests that MBS prepayments at any given refinance incentive will be less responsive to changes in interest rates than in a higher refi environment," UBS analysts said. Analysts from Countrywide Securities also noted that prepayment risk remains low, but the rally has reduced fears of severe extension risk.
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