Mortgages saw improved funding and strengthening dollar rolls at the beginning of last week. This was because the world government programs were starting to get a foothold. U.S. one-month Libor dropped nearly 90 basis points over the previous week, and mortgages rallied sharply on Monday. Real money, hedge funds and servicers actively bought down-in-coupon.
Contributing to the down-in-coupon move was a strong rally in Treasurys on the poor economic outlook from the recent data as well as from Federal Reserve Chairman Ben Bernanke's testimony to the House Budget Committee on that day.
Bernanke said that "the pace of economic activity is likely to be below that of its longer-run potential for several quarters." Given this, he supported another stimulus package from the government to help the economy.
It was a different story on Tuesday and Wednesday as profit taking picked up following a further flight-to-quality rally in Treasurys, along with the recent strong gains made in MBS. In addition, some investors were moving out of MBS and into agency debentures, as that sector had lagged recently.
Money managers, leveraged accounts and banks were better sellers, focused in 5.5s, while convexity investors remained better buyers. Supply picked up as well from its recent anemic levels of $1 billion or less per day and hit around $2 billion, primarily in 5.5s. Flows moved up-in-coupon because of the recent cheapening following the outperformance in lower coupons.
Treasurys gained as equities declined on poor earnings news and outlooks and fears of a recession.
Mortgage Bankers Association (MBA) Chief Economist Jay Brinkmann projected negative growth in 4Q08 and the first two quarters of 2009. For the year, he predicted real GDP growth of just 0.1% in 2009, down from 0.3% in 2008. A recovery is not seen until 2010 with a growth forecast at 3.4%. The housing market is expected to stay weak until the second half of 2009 and into 2010. MBA anticipates 3% growth in total existing homes sales in 2009 and 6% in 2010. This compares with an expected decline of 13% for 2008. Meanwhile, new home sales are estimated to decline 36% in 2008 and another 12% in 2009, and to surge 25% in 2010.
MBS performance has moved into positive territory for October. The Lehman Brothers MBS Index is outperforming Treasurys by 28 basis points month-to-date through Oct. 21. This compares very favorably to ABS (negative 486 basis points), CMBS (negative 562 basis points) and Corporates (negative 576 basis points).
Mortgage Applications Drop
Mortgage applications dropped 16.6% in the week ending Oct. 17 in response to a jump in mortgage rates. The Freddie Mac weekly survey reported that the 30-year fixed mortgage rate rose 52 basis points to 6.46% from 5.94%. The MBA reported that the Refinance Index fell a seasonally adjusted 23.5% to 1158.8, while the Purchase Index dropped 10.9% to 279.3. The Purchase Index is at its lowest level since late October 2001, while the Refinance Index is running near levels in mid to late August when mortgage rates were at similar levels. These levels were the lowest since the end of 2000.
As a percent of total applications, refinancing share was 42.6%, down from 46.4% previously. ARM share was one-tenth higher to 2.7%.
So far in October, the Refinance Index has averaged 22% lower than September, which suggests potential for further slowing in prepayments than currently anticipated for November. At this time, speeds in November (reported in December) are expected to be down more than 10% from October's estimates. Contributing to the slowing is four fewer collection days.
Mortgage Outlook
Wall Street research analysts were mostly favorable on the sector. For example, JPMorgan Securities analysts remained positive on the mortgage/Treasury basis as they expect agency spreads to benefit from GSE and Treasury sponsorship. For this to happen, they estimated that government purchases need to be at least $20 billion per month to get spreads to tighten.
Bank of America analysts favored an overweight to agency MBS versus Treasurys, partly because they expect the world government actions to help with funding, along with expectations that GSEs will be active buyers.
Citigroup Global Markets analysts, however, were neutral due to heightened basis volatility. They believe the new government programs favor other securities.
October prepayments are seen jumping nearly 50% in conventionals in response to the drop in mortgage rates in September and jump in refinancing activity following the government takeover of the GSEs. The largest percentage gains are in 6% and 6.5% coupons.
Meanwhile, GNMA projections suggest speeds increasing about 13% with the largest increases in 6s. Mortgage rates averaged 44 basis points lower to 6.04% in September compared with the average in August, while the Refinance Index was up 64% to 1725. October also has one extra collection day.
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