Last week brought another round of actions from global central banks and governments, including the U.S., as the financial crisis continued to spread despite government actions already taken, including the recently passed $700 billion bailout bill.
As the week got underway, there was a strong flight-to-quality, while mortgage volume was below normal with spreads ending wider to the curve.
On Tuesday, the mortgage market got a boost with the Federal Reserve's announcement regarding a Commercial Paper Funding Facility (see story p. 15). Mortgage volume picked up with spreads tighter to the curve. Flows were mixed with selling from hedge funds, banks and money managers, while servicers and real money were better buyers. Equities opened higher as well on the Federal Reserve's latest action, along with the Australian rate cut, but the gains couldn't be sustained, especially following mixed comments from Chairman Ben Bernanke at the National Association for Business Economics' 50th annual meeting. He noted that the "downside risks to growth have increased," although he added that in light of these developments, the Fed will need to consider whether the current policy stance remains appropriate. In the end, the Dow closed down 508 points to 9447.
As foreshadowed by Bernanke's comments, Wednesday saw central banks in Europe and the U.S. cut rates 50 basis points, but the markets were not all that enthused. Stocks opened higher but quickly gave up those gains and ended the day down 200 points after an up-and-down session. In addition, Treasurys were slammed by an unexpected announcement from the Department of the Treasury of a $40 billion reopening in four different off-the-run issues ranging from nine-year/four-month maturities to six-year/four-month maturities. The Treasury announced the auctions to help address severe market dislocations. Mortgages were initially pressured wider on selling, but the lower prices and wider spreads brought in banks, money managers and hedge funds.
Month-to-date through Oct. 7, Lehman Brothers' MBS Index lagged Treasurys by 50 basis points. The ABS Index was outperforming by 15 basis points, while CMBS and corporates underperformed by 316 basis points and 226 basis points, respectively.
Application Activity Rises
Mortgage application activity increased slightly in the week ending Oct. 3 in response to a dip in mortgage rates. The Mortgage Bankers Association noted that the 30-year fixed contract rate fell back below 6% to 5.99% from 6.07%. However, one-year ARM rates were unchanged at 6.60%. In response, the Refinance Index rose 0.9% to 1345.8 after plunging 35% in the week before to 1334 as mortgage rates jumped. The Purchase Index was up 3.2% to 314.5 following an 11% decline to 305.
As a percent of total applications, the refinancing share was 43.4%, down from 44% in the previous report. ARM share slipped to 2.3% from 2.5%.
The increase in mortgage rates in the latter half of September and the decline in refinancing activity will show up in the November prepayment report (released in December). Prepayment speeds are currently seen around 15% slower than October's expected surge in response to the drop in activity, slowing seasonals and four less collection days.
October speeds are projected to jump over 50% in FNMAs from September's average, about twice as much as previously predicted. Mortgage rates averaged 44 basis points lower to 6.04% in September compared with August's average, while the Refinance Index was up 64% to 1725. The month also has one extra collection day. The largest percentage gains are in 2007 and 2006 vintages and in 5.5% through 6.5% coupons.
Mortgage Outlook
In last week's Street research, analysts ranged from neutral to positive on the mortgage basis.
Bank of America analysts, for example, recommended that investors wait until the funding markets improve before moving to an overweight.
Meanwhile, Citigroup Global Markets analysts were also neutral, saying that they find more to dislike in the agency market than to like. Specifically, they noted that investors don't have the capital or the financing to take advantage of what would otherwise be relatively attractive valuations and that the traditional demand sources appear limited.
However, JPMorgan Securities analysts remained positive on the mortgage basis versus Treasurys and expect the government will be a solid sponsor for the sector. Analysts said that the large-scale Treasury issuance will begin will lead to mortgage purchases on the other side. "These are excellent technicals that support a mortgage/Treasury overweight," JPMorgan analysts wrote.
Meanwhile, UBS mortgage strategists recommended holding the overweight versus Treasurys.
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