Last week started off with more negative headlines inundating the markets. On Monday, AIG reported more losses than previously estimated. The news led to a flight-to-quality rally in the bond market.
This reversed on Tuesday when billionaire Warren Buffett announced that he had made offers to three top bond insurers to reinsure some $800 billion in municipal bonds. Buffet claimed that one firm had already rejected the offer, although he was waiting to hear from the two others. This put stocks in rally mode and Treasurys in selloff mode as some of the risk premium was removed.
With these market movements, MBS saw better selling overall from money managers, other real money buyers and hedge funds. With the spread widening, real money buyers emerged. There was heavy selling noted in FNMA 5s on Tuesday with some of the proceeds being reinvested in cheaper cross-sectors such as CMBS.
In the first couple days of trading, Asian buyers were not active participants, with the Chinese New Year's stalling activity. Originator selling was averaging roughly $1.5 billion per day with supply primarily in 5s and, to a lesser extent, in 5.5s.
Month-to-date through Feb. 12, the Lehman Brothers MBS Index was lagging Treasurys by 26 basis points. ABS and CMBS performance was worse than mortgages, however, at negative 41 basis points and negative 390 basis points, respectively. U.S. credit was better at negative 17 basis points.
The week was filled with more newsworthy events that provided an indication of potential first quarter growth, including the release of the retail sales report. In addition, Federal Reserve Chairman Ben Bernanke testified before the Senate Banking Committee on the economy and financial markets last Thursday.
Deutsche Bank Chief Economist Joseph LaVorgna said in a recent daily economic note that Bernanke's testimony at the Senate comes just two weeks before his semi-annual appearance before Congress. "Perhaps this speaks of how rapidly economic and financial conditions have changed and how concerned public officials are in an election year," LaVorgna said.
Street analysts' tone remained mostly neutral on the mortgage basis last week. Deutsche Bank made a list of mortgage market risks, including elevated volatility resulting from economic uncertainty, the Fed's policy with regard to lowering rates, capital adequacy for financial market participants and the extent of losses. At the same time, valuation levels can't be ignored. "The prudent strategy is to market weight MBS here given the high level of uncertainty about financial market events and the wider spreads available in other high credit quality securitized products today," analysts said.
Meanwhile, Lehman's outlook remains "grim," especially in terms of the supply/demand technicals. While supply is ramping up, analysts expect traditional mortgage investors to become less active going forward. While servicers have helped in the rally this year, they believe it will be limited in a further rally as servicing is now a convex asset. Bank selling is also a possibility as available-for-sale portfolios are currently at a premium to book, analysts said.
For February's prepayment report, expectations are for speeds to surge as a result of a sharp drop in mortgage rates and a spike in refinancing activity. For example, the 30-year fixed mortgage rate averaged 5.76% in January versus 6.10% in December. Contributing to a small offset is a lower day count in February - 19 versus 21 days.
Current initial projections suggest FNMA speeds will jump about 37% overall in February from January. The 2007 and 2006 vintages are predicted to surge close to 50%, while older vintages are expected to gain around 29%. March speeds are currently estimated to increase 30% from February, while April increases should be more moderate.
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