The trend last week was moving down-in-coupon as yields remained low and risks increased in premium coupons. In comments last week from Countrywide Securities, analysts noted "higher coupons are currently at risk - not because they're especially rich to lower coupons, but because high dollar prices have introduced a great deal of duration uncertainty."

Last week was also pool notification for 30- and 15-year conventional MBS. The story here, of course, is the FNCL 6 roll that traded through fail. In a recent report from Bear Stearns, researchers expect the short squeeze in FNMA 6s is likely to persist for the next few months. Demand for the coupon has been precipitated by the creation of Mega pools. In July, Bear Stearns notes that $20 billion in FNMA 6s were put into a Mega. This was 40% of all the production in 2004 through Sept. 10. In addition, there have been rumors of another $15 billion for January 2005 settlement. If true, says Bear, the combination of the July and January pools would account for 70% of all the production so far this year. Relief for the short position does not appear to be forthcoming in the near future either. Mortgage rates have dropped in the past several weeks and 6% production is likely to come off.

Originator selling was rather lackluster averaging at $1 billion per day, mostly in 5.5s. There is some concern about potential liquidity problems if supply doesn't improve. Overall, however, the tone in the market is supportive despite the rich fundamentals as technicals remain very attractive.

Over the Thursday-through-Wednesday period, spreads were two to three basis points tighter in 30-year Fannie Mae 4.5s and 5s; flat in 5.5s; and six basis points wider in 6s and 6.5s. In 15s, spreads were three basis points firmer in 4s; flat in 4.5s and 5s; and one basis point weaker in 5.5s.

Mortgage application activity holds steady

Mortgage application activity was little changed for the week ending Sept. 10. The Mortgage Bankers Association (MBA) reported that the Purchase Index slipped 4% to 456, while the Refinancing Index gained nearly 1.5% to 1973 from 1949. As a percentage of total applications, refis were 43.2% versus 41.4% previously. ARM share was essentially unchanged at 33.0% versus 32.9%.

Fixed mortgage rates declined as was expected for the week ending Sept.17. The 30-year fixed rate mortgage rate came in at 5.75%, down eight basis points from the previous week, according to Freddie Mac. This is the lowest rates have been since early April. The 15-year fixed rate was 5.13% versus 5.22% previously, while the one-year ARM rate reported in at 4.03%, up three basis points.

Given the decline in mortgage rates, Lehman Brothers says it expects the MBA's Refi Index to increase above 2000 in the weeks ahead if rates hold near current levels.

Prepayment outlook

The prepayment outlook has speeds trending higher for most coupons and vintages over the next few months in response to the summer decline in mortgage rates. Morgan Stanley stated that the average 30-year mortgage rate for September prepayments is 5.98%, down from 6.15% in August. October's data is reflective of a 5.83% average mortgage rate, and November's is 5.77%. Currently, consensus forecasts speeds on 2003 Fannie Mae 5.5s at 20% in September, up from 16% in August. October speeds are projected to increase to 22% CPR and then 23% by November. Meanwhile, 2003 6s are called at 31%, 34% and 35%, respectively, versus 26% CPR in August.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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