Mortgages generally were treading water last week. Volume was mostly below normal, though flows were generally balanced overall with the up-in-coupon trade more favored. According to Lehman Brothers, from the month to date through April 18, the MBS Index was up 14 basis points, having gained only a basis point since the previous Friday's close. The sector's performance for April, however, remains favorable compared with competing sectors: ABS (five basis points over), CMBS (five basis points over) and corporates (18 basis points over).
The higher yield levels and widening in OAS have failed to really stimulate strong buying. In midweek commentary, JPMorgan Securities analysts noted some recent concerns mentioned about MBS. There is the uncertainty regarding a rebound in volatility, as it is so low currently. Another is that the recent steepening in the curve has added to mortgages' duration and has pushed spreads wider. The final one is the recent heavy supply in 30-year fixed product. While supply has been on the rise, analysts believe that most of it is absorbable by overseas investors as well as banks and that hedge funds and money managers will pick up the remainder. In addition, analysts also anticipate that the widening in OAS will encourage money managers to become more active.
Also limiting flows over the week was the lack of data. There were only two key releases: CPI and housing starts. Inflation gains were less than expected, a factor that made the market rally sharply following its release on Tuesday and continue through Wednesday. In these two days, the 10-year gained 20/32nds with the yield slipping 3.4 basis points to 4.654% and with the 2s/10s curve recording some slight steepening.
Mortgages limped along to the sharp rally. Supply generally weighed on the market, as did higher volatility. Originator selling continues to average between $1.5 billion and $2 billion per day. On the bright side, overseas investors remain a presence in the market, though still not to the extent that most market participants want to see. The FNMA 5 roll kept things interesting again as it caught a bid. On Tuesday, the roll popped from 5/8ths of a 32nd to one by Tuesday's close, and reached 1.5 on Wednesday. At midday on Thursday, the roll was down slightly to 1.375.
Mortgage outlook
This week's economic calendar picks up with the initial first quarter GDP readings to be released on Friday. Other data include: consumer confidence on Tuesday; durable goods, and existing and new home sales on Wednesday; and the First Quarter Employment Cost Index and the final Michigan Sentiment reading on Friday. In addition, the Federal Reserve releases its "beige book" on Wednesday in preparation for the upcoming Federal Open Market Committee meeting scheduled for May 9. In Treasurys, there is a five-year TIPs auction on Tuesday, followed by two- and five-year note auctions on Wednesday and Thursday, respectively. This week should also see some month-end buyers starting to show up, though most activity is likely to take place next Monday.
Analysts were mostly neutral to positive on the sector last week. For example, Deutsche Bank Securities analysts remained tactically overweight on the mortgage basis because of attractive valuations and yield levels, an improved convexity profile, and the potential for some short-term supply relief from the ARM-to-fixed refinancings with the back-up in mortgage rates. UBS analysts held with their slight overweight recommendation. Concerns about supply are keeping them from being more bullish on MBS, they said. Bear Stearns says that market conditions for MBS are looking more promising on improved odds that the tighter swap spreads and for volatility to continue to edge lower. They also expect that foreign inflows into MBS to improve. Credit Suisse analysts, however, are neutral, in part because of the lack of investor conviction and concerns of a rebound in volatility, as it is so low.
Mortgage application activity falls
As expected, mortgage applications were down slightly for the week ended April 13. According to the Mortgage Bankers Association, the Refinance Index slipped just 0.3% to 2008.4 from 2015. Still, the index remains above 2000 for the seventh week in a row. At this time a year ago, the index stood at 1526, with mortgage rates over 30 basis poins higher. The Purchase Index declined 4.2% to 396.5. The MBA noted that the survey week covered the week after Easter, and that it was likely that home sales were a little lower, possibly affected purchase activity.
As a percent of total application activity, refinancing share was 43.6%, up from 42.8% previously. ARM share slipped further to 18.1% from 18.7%.
Mortgage rates slip lower
Mortgage rates declined last week as interest rates benefited from the favorable inflation reports. According to Freddie Mac's Primary Mortgage Market Survey, the 30-year fixed mortgage rate retraced the previous week's gains and moved back to 6.17%. A year ago, 30-year rates were at 6.53%. Meanwhile, 15-year fixed and five-year hybrid ARM rates dipped one basis point to 5.89% and 5.92%, respectively, while one-year ARM rates slipped to 5.45% from 5.47%.
Freddie Mac Chief Economist Frank Nothaft said he is hopeful that the stable mortgage rates experienced so far this year will have a stabilizing effect on the housing sector.
With the slight improvement in mortgage rates, mortgage application activity is expected to hold steady or possibly rise in this week's report. It appears that, after several weeks of declines, that the Refinance Index may be stabilizing as the latest survey recorded a decline of only 0.3% from the previous week.
Prepayment outlook
Speeds in April are projected to be flat in FNMAs and about 5% higher on average in GNMAs. While there is a two-day decline in the number of collection days in April from March, further strengthening in seasonals as well as increased refinancing activity in March are anticipated to be offsetting.
In May, speeds are currently projected to increase about 10% on a combination of a higher day count and an additional improvement in seasonals. Prepayment speeds for June are seen as staying steady or rising slightly higher compared with May prepay speeds with the day count declining to 21 days from 22.
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