Last week saw good two-way flows early on as originators brought nearly $3 billion on Tuesday and Wednesday, mostly in 5.5% coupons. Money managers and hedge funds readily absorbed it. Banks were mixed with profit taking noted; however, they were also strong buyers of 6% coupons. Finally, 5s saw good demand from CMO desks.
Over the past week, spreads on 30-year Fannie Mae's were flat in 5s and 6.5s, and one to two basis points tighter in 5.5s and 6s. Meanwhile, 15-year collateral did slightly better with 4.5s firmer by three basis points; 5s were two basis points tighter; and 5.5s in one basis point.
So far, the mortgage market has not been hit by significant convexity-hedging activity. In comments, Citigroup Global Markets said it considers 3.9% as the start of the convexity "danger zone" (see related story, p. 16). Analysts added that the mortgage and swap markets could be significantly affected if the long end of the Treasury curve rallies further. The firm said that the strong bond market rally so far this year has caused mortgage durations to shorten significantly, adding that if sustained, it could cause the reemergence of the "convexity trade." The effective duration of Citigroup's mortgage index was 3.42 years as of Jan.1, decreasing to 3.1 on Jan. 13, and at 3.05 on Jan 15.
Mortgage applications respond to drop in mortgage rates
The Mortgage Bankers Association (MBA) reported strong gains in mortgage applications for the week ending Jan.16. The Purchase Index rose nearly 13% to 502, while the Refinancing Index surged 52% to 3327. The Refi Index gains were a bit more than what many analysts expected. As a percentage of total applications, refinancing was 57.7%, up from 51.6% the prior week. The MBA also reported that the ARM share increased to 27.8% from 26.6%.
Mortgage rates slip further
Freddie Mac reported more mortgage-rate declines for the week ending Jan. 23. Both the 30- and 15-year fixed-rate mortgage rate fell two basis points to 5.64% and 4.95%, respectively. Meanwhile, the ARM rate came in at 3.56%, compared with 3.62% in the previous report. Mortgage rates are at their lowest since last July.
Looking ahead to this week's mortgage application survey, JPMorgan Securities expects the Refi Index to come in just shy of the 4000 mark given current rates.
At this time, 6s are fully refinanceable; this makes close to 40% of the mortgage universe have some level of incentive.
Is another refi wave in the making?
The current level of mortgage rates continues to raise questions regarding the possibility of another refinancing wave. In a recent report, Lehman Brothers said at similar mortgage rates seen a year ago, the Refi Index averaged over 5500. This time, however, the index is not expected to reach those levels, given its current composition.
Mortgage rates need to reach 4.8% for the MBS market to have the same aggregate rate incentive as January 2003, Lehman says.
In terms of prepayments, if rates hold near current levels, speeds are expected to slow around 5% to 10% in January and then pick up in February. Currently, the consensus prediction is speed increases of 10% to 20%.
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