Two-way flows were seen last week, with some profit taking following the previous week's strong performance by money managers, hedge funds and fast money. At the same time, insurance companies remained strong buyers. The big news in the MBS market was the collapse of the FNMA 6 roll, pushing spreads wider, and impacting strategies benchmarked to that coupon. Overseas buying activity also dried up last week.

Originator selling was slightly higher than its $1 billion daily average as Tuesday saw $2 billion in supply. Over the week ending Nov. 10, spreads on 30-year 4.5s through 6s tightened four basis points on average, while 15-year 4s and 4.5s were five basis points tighter.

The big plus in mortgages being the supply situation, analysts remain neutral to positive on the mortgage sector. In its weekly report, Bear Stearns analysts said, "investors should sell MBS short at their own risk," noting that while spreads may soften a bit given the recent strong tightening, supply technicals are a very dominant force. With last month's decline in total outstanding supply, the year-over-year balance of fixed-rate agency MBS is down for the first time since 1990, states Bear Stearns. So money managers benchmarked against fixed rate indices are chasing a shrinking pool of assets, suggesting spreads will continue to grind tighter. "As outstanding supply goes, so go spreads, "wrote analysts. Other investors, notably banks, are also sitting on substantial cash positions and waiting for attractive entry points.

Mortgage application activity declines

Mortgage application activity declined for the week ending Nov. 5 as mortgage rates increased. The Mortgage Bankers Association reported last week that the Purchase Index slipped 3% to 483, while the Refinance Index was off nearly 7% to 2149. Analysts had expected refinancings to hold at the 2300 area. As a percentage of total mortgage applications, refinancings were little changed at 45.2% versus 45.7% in the previous report. Meanwhile, ARM share increased slightly to 35.3% from 34.4%.

Mortgage rates rise with employment report

Freddie Mac reported that the 30-year fixed-rate mortgage averaged 5.76% for the week ending Nov. 11, increasing from 5.70% the previous week. Meanwhile, the average 15-year rate was 5.16%, rising from 5.08, and the one-year ARM averaged 4.16%, up from 4.00% the previous week.

Freddie Mac Chief Economist Frank Nothaft attributed the higher rates to October's "fervent" job growth statistics that led to the financial markets believing the economy is improving. "A large number of people reentered the workforce, leading to an uptick in the national unemployment rate to 5.5%, which we expect will ease back to 5.4% before the year is out," Nothaft said. "The end result translates into higher long-term mortgage rates this week."

October prepayments uneventful

Overall, October prepayments were uneventful with speeds in-line to slightly below consensus expectations. Gold speeds continued prepaying a bit slower than FNMAs. Bear Stearns attributes the prepay differential to diversification in Freddie Mac's seller distribution as well as to Fannie Mae pools containing a higher percentage of non-standard borrower characteristics. Analysts predict that if rates hold stable or sell off, this trend will remain. However, if rates rally strongly, speeds would likely converge.

GNMA speeds remain faster than conventional loans, which analysts attribute to the attractive refinancing opportunities that have encouraged Ginnie Mae borrowers to refinance into conventional loans. This phenomenon has left the lower credit quality borrowers in GNMA pools, which are currently experiencing higher default rates.

The near-term prepayment outlook is for speeds to hold flat to slightly higher in the November and December prepayment reports, suggested by the level of mortgage rates over the past two months and the Refinance Index response. For example, the Refinance Index averaged 2091 in September increasing, on average, to just 3% to 2161 in October. The limited response was due to 30-year fixed rate mortgage rates holding steady - averaging 5.75% in September and 5.72% in October.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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