Last week there was no shortage of news or data. The week opened with reports of a rescue plan put together by the Treasury Department and the Federal Reserve in an attempt to strengthen confidence in Fannie Mae and Freddie Mac, including the Fed authorizing the Federal Reserve Bank of New York to lend directly to the GSEs if it becomes necessary and the Treasury seeking Congressional approval to increase the GSEs' line of credit and to make an equity infusion into the companies if needed. All these measures are seen as temporary for 18 months.
As the domestic markets opened on Monday, the response to the news was initially positive with Treasurys lower and stocks higher. However, it reversed into a flight to quality as worries ramped up about more bank failures following IndyMac's takeover by bank regulators. MBS spreads closed tighter but were substantially off earlier levels. MBS volume was below normal because of all the uncertainty about the government's rescue of the GSEs, the state of financial institutions, housing, etc. Servicers reportedly were adding duration, while money managers were two-way.
Tuesday's focus was Chairman Ben Bernanke's semiannual Monetary Report to the Senate Banking Committee. The hearing was expanded to include Treasury Secretary Henry Paulson and Security and Exchange Commission (SEC) Chairman Christopher Cox. The report from Bernanke was rather downbeat. He noted that there was considerable uncertainty surrounding the Federal Open Market Committee's (FOMC) outlook for economic growth and that risks to FOMC forecasts were to the downside. He said that while inflation remained high, the FOMC believed it would moderate in 2009 and 2010. Many economists generally interpreted his remarks to mean that the Fed was on hold for the foreseeable future due to the fragile conditions in the economy and financial markets.
Meanwhile, Paulson tried to get across clearly to the markets and to the Senate panel that, "there are no immediate plans to access either the proposed liquidity or the proposed capital backstop" for the GSEs as, according to the Office of Federal Housing Enterprise Oversight, the GSEs are adequately capitalized. But considering market fears, he felt his proposed plan would help to alleviate market concerns regarding the GSEs and to increase confidence. The Treasury's proposals could be combined into the housing bill that is being reconciled currently. However, Congress - particularly on the Republican side - was mixed on helping the two GSEs.
Finally, Cox announced at the hearing that the SEC would issue an emergency rule that lasts from July 21 through July 29 that prohibits naked short sales of stocks of the GSEs and the 17 primary dealers. Cox said the action "aims to stop unlawful manipulation through 'naked' short selling that threatens the stability of financial institutions."
As trading got underway on Tuesday, Treasurys rallied as equities sold off sharply - down 200 points on the Dow with the 10-year Treasury up 29/32nds. Following Cox's announcement, stocks rallied off their lows, while Treasurys moved off their highs.
MBS volume was above normal in choppy, two-way flows. Mortgages opened tighter but weakened as Treasurys gained and selling picked up from hedge funds, insurance companies, pension funds, fast money and servicers - outright and versus Treasurys and swaps. Money managers were better buyers on the day, while Asian investors were quiet. While spreads ended the day slightly wider to the curve and swaps, they were off substantially from their intraday wides.
Mortgages continued to lag midweek in very light flows with sellers having the edge. Treasurys were selling off sharply as equities gained on financials following a favorable earnings report from Wells Fargo, a favorable response to the SEC's emergency order and further declines in oil prices. (At midday, oil was down another $3 a barrel to the $134 area.)
In other mortgage-related activity, 15s were mixed versus 30s; GNMA/FNMA was weaker on Monday following the government's rescue for the GSEs but gained on Tuesday on strong buying in GNMAs from overseas; and specifieds were pressured. Supply averaged between $1 billion and $1.5 billion per day through mid-week.
MBS performance has improved dramatically from negative 76 basis points month-to-date through July 8. Through July 15, Lehman Brothers' MBS Index is down just four basis points. At the same time, the ABS Index is at negative five basis points, CMBS is at 14 basis points and U.S. credit is down 64 basis points.
While the Fannie Mae/Freddie Mac rescue plan and Fed Chairman Ben Bernanke's Monetary Report to Congress were the top focus, there were key economic releases reported that also had some modest influence on the markets. Specifically, the inflation reports were worse than expected.
Given the government rescue plan for the GSEs, many analysts' tones were positive on MBS last week. For example, Barclays Capital analysts recommended staying overweight on the mortgage basis. They believe that the government's plan to support the GSEs is a "big positive" and that based on the various government officials' statements, there is a push toward "business as usual for now." This suggests the GSEs' continued participation in the mortgage market through not just its guarantee business, but also by purchasing MBS. Analysts recommended, however, hedging out the volatility exposure in MBS over the next couple weeks as earnings season gets underway.
JPMorgan Securities analysts suggested owning mortgages versus Treasurys on the possibility that government intervention could lead to greater Treasury supply. This would also have the effect of tightening swap spreads, said analysts, so they also recommended an overweight versus swaps. However, they do not recommend an overweight versus agencies, as agency debt benefits as well from the government intervention.
Mortgage Applications Up
Mortgage application activity was higher in the week ending July 11, reported the Mortgage Bankers Association. The rise was a response to a sharp drop in mortgage rates. The MBA reported the 30-year fixed contract rate dropped 21 basis points to 6.22%, while the one-year ARM rate was lower by 8 basis points to 7.24%.
The Refinance Index rose 6.9% to 1474.9. The index has increased for three straight weeks from a low of 1212.2 in the week ending June 20. Meanwhile, the Purchase Index slipped 1.7% to 359.7.
As a percent of total applications, refinancings increased to 39.2% from 37.3%. ARM share fell to 9.1% from 10.0%.
Prepayment speeds are expected to see further deceleration in July in response to overall market conditions and higher mortgage rates that sent application activity tumbling in June. The Refinance Index averaged 1371 in June, down 33% from May's average.
The 30-year fixed mortgage rate averaged 6.32% compared to 6.03% previously. Barclays Capital analysts also said the increase in guarantee fees that the GSEs implemented on June 1 is impacting activity. These fees add to the difficulty in originating low-FICO/high-LTV loans, they said. The Federal Housing Administration also implemented risk-based premiums beginning July 14.
Currently, speeds are seen slowing about 10% to 15% in July from June, with the largest percentage declines showing in 5.5s and higher.
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