As the 10-year Treasury sold off sharply following President George W. Bush's nomination of Ben Bernanke as the new Federal Reserve chairman to replace Alan Greenspan, the bond markets reacted negatively to the uncertainty of how Bernanke may deal with inflation. Mortgages were hit by heavy servicer selling, totaling in the several billions of dollars and primarily in 30-year 5s and 5.5s.
Other investors were also better sellers. However, both real and fast money began to take advantage of the cheapening Wednesday afternoon and it was carrying over into Thursday's session as Treasurys held a more supportive tone. Also expected late week and into Monday is some month-end index buying. The MBS Index is estimated to extend 0.10 years, according to Lehman Brothers.
Overall, though, the near-term outlook for mortgages is not stellar. Issues include strong supply, poor rolls in 30s, and richening Treasury repos. In addition, a further sell-off will lead to more servicer selling as they shed duration. Another negative is continued yield curve flattening, which is not a favorable environment for mortgages.
Analysts are mostly neutral to slightly negative on the sector, though last week's cheapening may see some temporary upgrades to recommendations. For instance, in mid-week comments from JPMorgan Securities, analysts said that the mortgage widening was approaching levels where they might upgrade their basis view from underweight.
Refi Index finally responds to higher rates
The Refinance Index finally responded to higher mortgage rates and declined below 2000 for the first time since mid-April. According to the Mortgage Bankers Association, the Refinance Index fell nearly 9% to 1917 from 2096 for the week ending Oct. 21. The Purchase Index was down 7% to 466 from 504. Expectations are that the Refinance Index will head towards 1800 in the coming reports.
As a percentage of total application activity, refinancings were little changed at 42.5% versus 42.8% previously. The ARM share was also relatively flat at 29.5% versus 29.3%.
Not surprisingly, mortgage rates continued trekking higher, according to Freddie Mac's weekly survey. Last week, the agency reported that the 30-year fixed mortgage rate rose five basis points to 6.15% - the highest it has been since 6.21% for the week ending July 2, 2004.
Freddie Mac also noted that 15-year fixed rates moved up to 5.69% from 5.65% previously. In ARM product, 5/1 hybrid ARM rates averaged 5.63%, also up four basis points, and the one-year ARM rate gained just two basis points to 4.91%.
Commenting on the move higher in rates, Freddie Mac's Chief Economist Frank Nothaft noted, "Obviously, refinancing is going to take the biggest hit as mortgage rates tick up." He added that refinancing made up roughly 40% or more of the total volume of mortgage originations during the last 13 months. But this share should diminish as mortgage rates continue to increase. "Going forward, homeowners wanting to use some of the equity in their homes for home improvement or other purposes will make up a larger portion of the refinance business," Nothaft added.
Prepayment outlook
The October prepayment report will be released on Friday evening. Expectations are for speeds to slow around 7% to 8% compared to around 20% in September. Over the period impacting the October report, mortgage rates were slightly lower on average than for September's report, and the Refinance Index was relatively stable.
David Montano, head of mortgage research at JPMorgan Securities, expects an 8% to 10% drop in October prepayments, noting that the MBA Refinance Index suggests a 5% to 7% decrease since there is one less collection day and seasonal turnover should slow by 2% to 3%. As a consequence, Montano said that paydowns are projected to be $49 billion.
Looking ahead, November speeds are seen slowing in the 8% area, with December's slightly less at around 5% to 6%. Speeds could be revised slightly downward given the increase in mortgage rates.
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