For the mortgage markets, the European Union (EU) crisis was more background noise for the first half of the week with HARP 2.0 taking over the headlines.  

Nov. 15 was the date that the GSEs were scheduled to release the operational details and they made investors wait until 4:00 PM ET to get that information.

Ahead of that on Monday, trading was focused on selling in higher coupons and moving down in coupon. It reversed on Tuesday even before the HARP 2.0 guide bulletins were released.

Contributing to improved confidence that prepayments resulting from HARP 2.0 were adequately priced in was the testimony by Federal Housing Finance Agency (FHFA) Acting Director Edward DeMarco before a Congressional Panel.

DeMarco reiterated what was said in the October press release and conference call where it was said that the announced changes to the HARP can double the number of homeowners helped via the program, and that to-date some 900,000 homeowners have refinanced through it.

He also noted that industry participation in HARP is not mandatory and that implementation schedules would vary as the various lenders, mortgage insurers and other market participants modified their processes.

After the closing remarks, higher coupons began strengthening as initial reads on the HARP 2.0 changes were in line with expectations. This continued through Wednesday as most Wall Street research analysts held to their previous expectations of around a 4 to 8 CPR increase in one-year speeds.    

EU focus took over on Thursday with Treasurys rallying and the 10-year note yield declining below 2.0% to 1.957% as contagion fears ramped up as borrowing costs surged for France and Spain.

Mortgages were unable to keep up with the rally due to its inherent negative convexity. Investors, especially yield buyers, were also more sidelined at the 2.0% area with a preference toward 2.10%.

Adding to MBS' woes was the deterioration in Dec/Jan rolls due to the higher prices as well as the usual year-end balance sheet constraints that kick in at this time of year. For the most part, flows were two-way in lower coupons, while profit taking was  seen up-in-coupon following their recent gains.  

As trading got underway on Friday, investors were less risk averse on talk that the European Centra Bank could lend money to the International Monetary Fund that would be used to finance bailouts for the more debt-burdened countries. Mortgages were holding up better with prices lower. Heading into mid-day, spreads were 2-3 ticks tighter versus 10-year notes across most of the stack, and slightly wider to swaps.  

In other mortgage activity, GNMA/FNMA swaps steadily firmed through mid-week with the 4.5 swap at nearly three points before easing back. The strength was a result of overseas buying and the HARP news.  

Gold FHLMC/FNMA saw some improvement as well following the HARP news. However, Treasury sales of FHLMCO Golds continued to weigh on the swap. Interest in specified pools was steady between weaker rolls and preference for call protection; Treasury BWICs remained steady as well. 15s mostly underperformed 30s over the week on the yield curve flattening.

For the week, Tradeweb volume averaged 90% through Thursday compared to 79% in the prior week.  

Mortgage banker selling averaged $1.4 billion per day versus $1.6 billion previously, which was a favorable dynamic against Fed buying during the week. For the week ending Nov. 16, the Federal Reserve bought $5.55 billion or $1.4 billion per day on average. Negative convexity weighed on MBS performance with excess return versus Treasuries for Barclays Capital's MBS Index at -57 basis points month-to-date. The 30-year current coupon yield was lower to 3.18% from 3.21%, while the spread to 10-year notes and swaps widened to 122 basis points and 102 basis points, respectively, from 115  basis points and 98 basis points.

Prepayment Outlook

The next three prepayment reports are expected to be very uneventful affairs. The 30-year prepayment speeds are projected to increase around 5% or less in November while December and January speeds are expected to be mostly flat to slower on average across the coupon stack. 

Prepayments associated with HARP 2.0 may begin to show up in the February report as lenders can start taking applications on Dec. 1.

Bank of America Merrill Lynch analysts estimated that with delays required to implement some of these changes, the full impact will likely not be felt until the second quarter of 2012. Credit Suisse said they expected the full ramp up of HARP 2.0 to be delayed until May 2012 for FNMA speeds as Fannie Mae's increased automated valuation model coverage under DU Refi plus won't be available until March 2012.

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