The markets continued to grapple with the impasse in Washington regarding raising the debt ceiling as the clock steadily ticks down to the Aug. 2 deadline, and the prospects of a ratings downgrade increase.
At times the market traded off on the impasse. However, Treasurys also rallied on poor earnings news, weaker than expected economic data, and continued debt issues regarding Greece and other European Union countries.
While MBS investors acted in typical fashion on sell-offs — adding on the weakness — real money, money managers, hedge funds and servicers were also actively supportive on rallies as current coupon spreads remained in the higher end of this year's range of 95 basis points to 100 basis points to 10-year notes and 85 basis points to 90 basis points to 10-year swaps.
The sector wasn't oblivious, however, to the risks in the market resulting from the debt impasse. On Wednesday morning, for example, short-term funding increased because of fears associated with a downgrade, which pressured rolls lower as selling in the 4, 4.5 and 5.0 rolls picked up.
The resulting weakness in the cash market brought in buyers beginning around mid-day. The majority of activity early in the week was focused in 4% through 5% coupons, but moved down to 4s and 3.5s by week's end as the 10-year Treasury note busted through 2.90% to 2.805% as of Friday's close.
In other market activity, 30-year 6.5s staged a mini-comeback into mid-week as real money took advantage of the prior week's sharp underperformance. Meanwhile, dollar rolls moved lower as funding costs increased on the debt crisis, with active roll selling on Wednesday.
The 15s lagged 30s as the curve flattened while GNMA/FNMAs were higher benefiting from lack of supply and a street short. It was a mixed week in specifieds as Treasury sales apparently wound down by mid-week as it appears to have reached its monthly goal of $10 billion.
Mortgage banker selling averaged just $1.3 billion per day, similar to the prior week. MBS performance deteriorated with Barclays Capital's MBS Index underperforming Treasurys by 49 basis points month-to-date through July 28 compared with negative 36 basis points in the prior week.
The sector lagged ABS (+12 basis points), CMBS (-24 basis points) and Corporates (+28 basis points). The 30yCC yield remained the same at 3.92% with the spread to 10-year notes one basis point wider to +97 and by two basis points to +87 to 10-year swaps. Volume was elevated for the week with Tradeweb reporting an average of 131% compared with 107% previously.
Prepayment Outlook
Prepayments are expected to increase around 5% in July from June on 30-year agency MBS with the largest percentage increases in 5% coupons and lower in response to a pickup in refinancing activity in June as a result of lower mortgage rates.
Paydowns are projected at $74 billion with net issuance expected to be negative based on current month-to-date gross issuance, which stands at $64 billion.
Speeds are expected to peak in August at less than 10% higher than July with day count a significant influence at 23 days from 21. The increase is expected to reverse in September as the number of collection days falls back to 21.
