MBS performance is off to a positive start in October. Lehman's MBS Index records 18 basis points in excess return in the first two days of trading. This compares to -3 basis points in the ABS Index, +2 basis points in the CMBS Index and +8 basis points in the Corporate Index. For September, MBS ended up in last place in this group after leading for a good part of the month. For September, the MBS Index outperformed Treasurys by 18 basis points versus +47 basis points for ABS, +65 basis points for CMBS and +21 basis points for corporate debt.
MBS volume was running slightly below normal in the first part of last week because participants were waiting for employment news through the ADP Employment report, ISM Non-Manufacturing and especially Friday's employment report. Information from ADP and ISM suggests a rebound in non-farm payrolls employment from August's decline of 4,000. Currently, observers expect to gain 115,000 in nonfarm payrolls for September, and for the unemployment rate to inch up to 4.7% from 4.6% in August.
Overall flows were directed toward better buying. There was widespread participation, including money managers and foreign central banks focused in 6s, insurance companies in 5s and 5.5s, and fast money in 6s and 6.5s, though midweek they were moving down in coupon into 5.5s. Money managers were also said to be active in specified assets. Overseas was mostly quiet in the first half of the week as China was out on holiday for three days. In Ginnies, flows were limited because the market is still waiting for a decision on the FHASecure program. Originator selling averaged between $1.5 billion and $2 billion per day. Supply was primarily in 6% coupons.
Data in the first few days of trading last week (the ISM Index, Pending Home Sales, ADP Employment, and ISM Non-Manufacturing) were generally in line with expectations, or slightly better. This contributed to less certainty regarding another 25-basis-point cut in the fed-funds rate at the end of October. 2s10s slope was at 61.8 basis points at the close of Friday, Sept. 28 and was at 55.4 basis points at the close of Tuesday, Oct. 2.
Outlook
The holiday-shortened week includes some key economic releases, particularly on Friday with PPI and retail sales. Other reports include wholesale trade on Wednesday; import prices, initial claims and international trade on Thursday; and business inventories and consumer sentiment on Friday.
Fedspeak begins on Tuesday with the release of the FOMC minutes from the Sept. 18 meeting. Federal Reserve Chairman Ben Bernanke is scheduled to speak on Friday via video to a Federal Reserve Bank of Dallas conference, including board governors Frederic S. Mishkin and Donald L. Kohn, plus Federal Reserve Bank presidents Janet L. Yellen of San Francisco; Eric S. Rosengren of Boston; and Richard W. Fisher of Dallas. The U.S. Treasury is also scheduled to auction a reopening of 10-year TIPs on Thursday.
In MBS, Tuesday begins the 48-hour notification for Class A (30-year conventionals) and on Friday for Class B (15-year MBS). Rolls are expected to drift lower as the 48-hour day approaches. Issues that continue to plague the rolls market are funding costs and balance-sheet constraints.
In remarks from UBS last week, analysts said MBS was somewhat cheap. However, they expressed concern about the heavy agency supply looming. JPMorgan Securities currently estimates net agency fixed-rate issuance to top $500 billion in 2008, higher than 2007's expected record issuance estimated to be $450 billion. Barclays Capital also mentions other concerns, such as an ongoing weakness in housing that increases extension risk and hurts discount MBS, bloated bank balance sheets that should keep funding costs elevated for MBS investors, and low expectations that the GSEs will add MBS in size anytime soon. Given the risks, most favor up in coupon and specifieds.
Mortgage Application Activity Slows 2.7%
Mortgage application activity slipped in the week ending Sept. 28, said the Mortgage Bankers Association. The Refi Index declined 3.8% to 1950.4, while the Purchase Index was 1.8% lower to 411.4.
As a percent of total applications, refinancing share was little changed at 46%, compared with 46.4% previously. ARM share increased to 13.8% from 12.2%. The average contract interest rate for 30-year fixed mortgages fell six basis points to 6.32%; one-year ARM rates jumped to 6.21% from 6.09%.
Prepayment Outlook
Speeds in September are expected to slow around 17% overall. The decline comes primarily on a drop in the number of collection days to 19 from 23 in August. At the same time, mortgage rates were improved at 6.57% average in August versus 6.70% in July, which stimulated refinancing activity based on results of the Refi Index. The September prepayment reports are released late Thursday, Oct. 4, for conventionals and on Friday, Oct. 5, for Ginnies. Paydowns are estimated to be in the low $30 billion area.
Prepayment speeds continue to recover in October, as the day count increases from 19 to 22 days. In addition, speeds are also likely to reflect the lower mortgage rates and a pickup in refinancing activity. In September, the 30-year fixed mortgage rate averaged 6.38%, down 19 basis points from August's average. The MBA's Refi Index averaged 1954, an increase from 1823 in August, or 7%. Looking further out to November, speeds are predicted to be about 5% lower.
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