Spreads have remained unchanged with a bias toward the tighter end as market observers await economic reports to indicate if the Federal Reserve will raise shirt-term interest rates later this month. In the mean time, all focus has shifted toward Ginnie Mae, as it contemplates changing its Program I securities to be more competitive with the Federal Home Loan Banks.

In light of this news Ginnie Mae Program II securities have been trading extremely cheap, said a mortgage-backed securities trader. "I think the short term effect is that they're very cheap because there will be no supply," he said. "Long term, I think the whole market's going to die and there'll be no liquidity."

He added that for buy and hold investors, it's a good time to buy.

In turn, the Fannie Mae/Ginnie Mae swap market is expected to weaken a great deal over time, creating more volatility in a market that already vulnerable to event risk. While traders urge that buying Fannie Mae/Ginnie Mae swaps on the dips makes a smart investment, levels are not expected to return to those of last fall and winter.

25 or 50?

Rumors are abound expecting the Fed to raise short-term interest rates 50 basis points at its May meeting. However, historical statistics indicate that the Fed has only made a 50 basis point move three times since 1990. Many are expecting a 25 basis point increase.

With Treasurys lower on these rumors, mortgages had the chance to outperform by 1.2 ticks by market close last Thursday. Higher rates had prompted investors to move up-in-coupon.

Spreads had only tightened two basis points in Ginnie Mae 6s through 8s, while conventionals moved in two basis points on 6s through 7s. As investors moved up-in-coupon, 7.5 through 8.5 conventionals tightened four to five basis points.

"I tend to think that assuming there's no big gapping out in swap spreads or a lot of panic, I tend to like mortgages here and think they'll kind of slowly ratchet in," said an MBS trader. "I think there's pretty good value in the market, but it is vulnerable too. As swaps tend to be very volatile and agencies have been volatile, I think mortgages have been affected by that and one of the more interesting things to do now is watch these various intermarket spreads and try to pick your spots into one market and not in the other."

Who's Competing with Whom?

With news indicating that the FHLBanks' Mortgage Partnership Finance program going through a change to cap the amount of Federal Housing Administration product its members can hold, it has created a very confusing situation.

"What the home loan banks do with that program is still up in the air and it seems to be they have the potential for snatching defeat from the jaws of victory, with this notion of capping the FHA purchases," said one MBS trader. "They're going to find that competing with Fannie and Freddie is a lot different than trying to compete with Ginnie Mae." He added that capping FHA purchases has potential to damage the program.

Ginnie Mae, which has historically been slow to react to market changes, has been trying to change its Ginnie Mae I program. The trader urged the agencies "not to tread with Fannie and Freddie, who are much more fluid in how they do business and are much more responsive to mortgage forces. They're going to find it much more difficult to compete with them successfully."

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