Ahead of the Federal Open Market Committee meeting last week, mortgage flows were quiet but picked up sharply following the statement that suggested the FOMC is nearing an end to its tightening cycle. Following the announcement, mortgages saw active two-way trading with buying from real and fast money and banks - particularly in 5s and 5.5s - with profit taking showing up as spreads hit daily tights. Servicers have been relatively quiet lately, however, if the 10-year Treasury yield moves through 4.40%, they are expected to become active buyers - particularly in 5% coupons. Originator selling was mostly average at $1 billion per day, however, with the strong rally on Wednesday, supply totaled nearer to $1.5 billion.
The near-term outlook has turned more favorable. In mid-week comments, JPMorgan Securities analysts suggested covering tactical basis shorts and shifting to neutral. They expect real money purchase activity in early January. Also, they anticipate additional outperformance of perhaps three to five ticks if the 10-year Treasury remains between 4.40% and 4.60%. In research from UBS, analysts are maintaining their modest overweight as mortgages are expected to continue trading in their recent ranges, waiting for additional information on whether the FOMC has completed its tightening cycle.
The longer-term outlook is mixed. Deutsche Bank Securities analysts believe "there will be positive momentum in favor of agency passthroughs in 2006." Unlike some firms, Deutsche Bank anticipates that 30-year MBS net supply will average $10 billion to $12 billion over the next three months, after averaging $24 billion per month in September and October. On the demand side, the GSEs are pretty much finished with their portfolio downsizing and could become buyers next year. There is also the potential that overseas demand will pick up. As a result, Deutsche Bank analysts believe "the supply and demand technicals for the fixed rate agency market will turn favorable." Bear Stearns sees challenges for the sector with the FOMC still on its tightening bias and the relatively flat yield curve. In addition, with higher financing costs, preferences for Treasury liquidity, increasing supply and uncertain demand from banks and GSEs, spreads are anticipated to widen versus Treasurys. However, once the FOMC completes its tightening cycle, Bear analysts say mortgages "could be one of the best asset-classes in fixed income if the 10-year remains range-bound as expected."
Application activity declines 6% overall
Mortgage application activity declined for the week ending Dec. 9. The Mortgage Bankers Association reported that the Refinance Index was down nearly 10% to 1442 while the Purchase Index slid 3.50% to 478. The slowing was in line with expectations. As a percentage of total application activity, refinancings were 40.2% versus 41% previously. ARM share was slightly greater at 33.5% compared to 33.1% for the week ending Dec. 2.
Mortgage rates held fairly steady over the past week. According to Freddie Mac's weekly survey, the 30-year fixed rate mortgage rate averaged 6.30% last week versus 6.32% the prior week. Meanwhile,15-year fixed rates were also down two basis points to 5.85%. On the adjustable side, rates slipped one basis point to 5.77% on 5/1 hybrid ARMs and 5.15% on one-year ARMs.
Freddie Mac's Chief Economist Frank Nothaft noted, "Earlier in the week, interest rates were a bit higher, as financial markets were a little anxious about what language the Federal Reserve would use in its statement this month." He added that when the FOMC signaled that its interest rate tightening could end soon, the financial markets were relieved while rates eased somewhat.
With mortgage rates holding stable, expectations are for application activity to hold near current levels, although the approaching holidays may contribute to further slowing.
Expectations are for speeds in December to slow around 12% to14% in 30-year FNMA 5.5s and higher, and 6% to 8% in 4.5s and 5s. Bear Stearns' Senior Managing Director Dale Westhoff says the report should reflect a 25 basis point increase in mortgage rates to 6.30%, a 15% decline in the MBA Refinance Index, a 10% decline in the Purchase Index, and seasonal slowing of nearly 10%. Speeds are currently projected to slow 15% in January, with February speeds down just around 5%.
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