Last week's trading sessions were primarily influenced by the inflation news and the Federal Open Market Committee minutes. Both the PPI and CPI reports showed an improvement in inflation. The overall PPI plunged 1.6% in October, versus a consensus decline of 0.4, and the core was down 0.9 versus expectations of a 0.1 increase. Meanwhile, CPI declined 0.5 versus expectations of -0.3, and the core came in at 0.1 versus a consensus estimate of 0.2. Offsetting the market strength was a stronger than expected Empire Manufacturing Survey and the FOMC minutes. The minutes suggested the Federal Reserve would remain on hold for the foreseeable future as the committee expects economic growth to remain decent into next year, which reduces the odds of an easing in rates anytime soon. Overall, the 10-year Treasury held within a fairly tight range - closing between 4.59% to 4.62% - with volatility remaining low, resulting in a relatively healthy environment for mortgages.
According to Lehman Brothers, the MBS Index has outperformed Treasurys by 23 basis points so far in November, which brings the year-to-date performance to an impressive 111 basis points. The week saw two-way flows with participants - money managers, banks, overseas, hedge funds, servicers - taking advantage of any weakness to add, and rallies to take profits, particularly Asian investors. While activity was all along the coupon stack, depending on the market changes and yield curve shifts, it was focused primarily in the belly of the stack. Originator selling was generally uneventful, holding to just over $1 billion per day on average.
Analysts' sentiment remains favorably disposed to mortgages. For example, Bear Stearns analysts noted that market conditions (low volatility, tighter swap spreads) continue to favor a tightening in spreads. Refinance risk is not a concern at the moment, they added, saying that would require a decline of 20 basis points in mortgage rates. Countrywide Securities analysts expect mortgages to do well within the 4.54% to 4.83% range, partly on a favorable supply/demand balance. They expect mortgages would underperform on a break through 4.54%. Specifically, a 4.40% yield on the 10-year Treasury is noted as the convexity inflection point with significant increases in refinancing risks and higher volatility.
This week is expected to be relatively quiet with many participants out for Thanksgiving break. Thursday will have a full close, with Wednesday and Friday seeing early closes at 2:00 p.m. eastern time. Economic data is scarce with just leading indicators on Monday, and initial claims and the final Michigan Sentiment reading on Wednesday. Also on Wednesday, the U.S. Department of Treasury announces details of its upcoming two- and five-year note auctions.
Refi Index crosses 2000
Mortgage application activity rose 4.3% for the week ending Nov. 10, according to the Mortgage Bankers Association, with both purchase and refinancing activity gaining for the second week in a row. The Refinance Index was up 6.5% to 2022.2. This is the first time since the week ending Oct. 14, 2005 that the index has been above 2000. A year ago, the Refinance Index was at 1702 with mortgage rates at similar levels - though rates were trending upward.
Meanwhile, the Purchase Index rose 2.7% to 412.9. This is the highest the index has been since mid-July when it was at 425. A year ago, the index was at 478.
As a percentage of loan applications, refinancings were 48% compared to 46.3% in the previous report. This compares to an average of 38% for the first nine months of this year, and is the highest level since February 2005. ARM share was 25.5%, down from 26.4%.
Prepayment outlook
Speeds in November are expected to slow 3% to 4% on average with discounts showing larger percentage declines (around 6%) versus par and premiums (about 2%). Factors influencing the report include slowing seasonals and one less collection day. On average, the Refinance Index was up less than two percent in October versus September; 30-year mortgage rates averaged just four basis points lower. Looking out to December and January, speeds are anticipated to slow about 6% each month.
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