This week's primary influencing factor on trading was Friday's address by Federal Reserve Chairman Ben Bernanke at the annual Jackson Hole Economic Policy Symposium hosted by the Federal Reserve Bank of Kansas City in Wyoming.
Whereas last week markets were buoyed by quantitative easing (QE) prospects following the Federal Open Market Committee's (FOMC) minutes and the potential for a heads up from Bernanke's speech, this week's markets were less sure especially with a slightly better-than-expected 2Q12 GDP revision, while the Beige Book provided no strong guidance on QE prospects with details providing a case as much for it as against.
This was particularly evident in mortgage banker supply which seemed slightly elevated for the market fluctuations. Originator selling averaged $2 billion per day over the period Friday through Thursday.
While normal on average, there were periods of technical imbalances as many investors were out on end of summer vacations, while uncertainty about QE tempered the various investors with the exception of the Fed. Its buying held at a steady pace that averaged out to an unchanged $1.3 billion per day, which indicated coverage of over 60% of the supply.
By Thursday, however, the tone turned more supportive in part as the sector was entering into a time of the month that typically draws in better buying: month-end, reinvestment of principal paydowns, the reduction in vol associated with the employment release, and Class A (30-year FNMA and FHLMC Golds) pool notification. It was further encouraged as prices moved higher after mid-week price and spread cheapening.
The stars aligned for lower coupons on Friday as in addition to month-end buying, investors were relieved that QE remained very much on the table with possibly further confidence garnered from Bernanke's favorable review of QE1's and QE2's impact on helping the economy. On top of these, Federal Housing Finance Agency announced an average 10 basis points increase in g-fees to take effect later this fall and that will lower prepayment risk, particularly on the lower coupons.
In other activity, a flatter yield curve led to 15s lagging 30s, while overseas investors were not inclined to get too involved in GNMAs ahead of Bernanke's speech on Friday that led GNMA/FNMAs lower. Trading in specified pools was active, however, between investor BWICs on improved payups as well as some early Originator Cycle BWICs with 48-hour day looming in a couple of weeks.
Generally demand remained good for call protected paper; however, there was selling noted in the 80-90 LTV MHAs that seems instigated partly based on concerns raised in a report from Barclays Capital citing that improving home price appreciation (HPA) and mortgage insurance (MI) availability should move this cohort of borrowers into a better position to refnancei sooner than originally expected.
The last two weeks of August are traditionally dubbed "the summer doldrums" as many are off on vacations before school starts back up. This was reflected in the volume figures with Tradeweb reporting at an average of 86% through Thursday, while last week was just slightly better at 92%. Excess return to Treasurys was -6 basis points over week through yesterday on Barclays MBS Index with the month-to-date return at +9. The 30-year current coupon yield declined four basis points to 2.51% with the spread to 10-year notes two basis points wider to 89.
Some normalization will return next week in terms of attendance as most participants will be back to work, but we are still a long ways from economic normalization. So just as eventful the last two weeks of August turned out to be in regards to QE and the economy, the first two weeks of September should be as well. Luckily many should be well rested after vacations and Labor Day breaks!
On the near term agenda are August nonfarm payrolls released Friday, and then the week afterwards the FOMC will meet and issue a statement, economic projections and hold a press conference on Sept. 13. Deutsche Bank Securities economists believe it will take a print below +100k or an uptick in the unemployment rate to make policymakers feel pressured to act. At this time, consensus shows +135k in NFP for August, down from 163k in July, while the unemployment rate is expected to tick back to 8.2% from 8.3%.
On top of that, Europe will be back in the headlines as well with an European Central Bank meeting scheduled this coming Thursday and expectations are that it will detail a bond buying plan.