The macro events surrounding the European Union's (EU) sovereign debt with increased worries about Italy and Spain and the U.S. debt ceiling talks — including downgrade warnings from the rating agencies if an agreement wasn't reached soon — dominated this week's headlines.
Also adding to the mixwas Federal Reserve Chairman Ben Bernanke's semi annual Monetary Policy Report to Congress that happened midweek as well as the release on Friday of the European bank stress tests.
EU issues were on the front burner at the start of the week fueling the flight-to-safety rally further with the 10-year note up over 3/4s of a point by Monday's close with the yield declining to 2.917% from 3.016% as of Friday's close. The higher prices kept many MBS investors sidelined with higher coupons pressured on selling.
The EU issues moved to the backburner mid-week because of news that the EU might hold an emergency meeting at the end of the week to deal with Greece further and its potential contagion impact on Italy and Spain.
This allowed for some calmer conditions and less risk aversion that was further helped on Wednesday by comments from Bernanke in his testimony before the House Financial Services Committee saying that additional stimulus was possible if conditions warranted.
More specifically, he stated that the Fed "remains prepared to respond should economic developments indicate that an adjustment in the stance of monetary policy would be appropriate."
He went on to add that "the possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might re-emerge, implying a need for additional policy support. Even with the federal funds rate close to zero, we have a number of ways in which we could act to ease financial conditions further."
Buying began to emerge on Tuesday and picked up on Wednesday with more favorable pricing conditions. Support came from hedge funds, pension funds, real money, money managers, insurance companies and servicers with the purchases focused in lower coupons both outright and versus Treasurys and swaps while fuller coupons continued to lag.
Widespread support continued on Thursday with help from lower prices that even was attracting some interest up in coupon. Volume, however, was limited with some attribution towards the debt ceiling uncertainty. Testy exchanges between Republicans and Democrats regarding the debt ceiling negotiations led to warnings from Moody's Investors Service late Wednesday and Standard & Poor's on Thursday that if an agreement wasn't worked out soon the U.S.' 'AAA' debt rating would be at risk.
Mortgages bounced around on Friday as Treasurys moved between lower earlier in the morning to firmer as the day progressed following weaker than expected economic news. The morning lows briefly attracted buying from money managers and hedge funds, while originator selling was limited helping firm up spreads. However, a pickup in mortgage banker and other selling turned the stack wider at mid-day by around three ticks.
The 15s outperformed 30s periodically when buying from REITs and banks were present. GNMAs/FNMAs were mixed earlier in the week, but were higher on Thursday with the GNMA/FNMA 5.0 swap setting a new record at 2-03+ points. Ginnies were particularly supported by overseas buying.
In specifieds, pay-ups on 5.5s and 6s increased on a pick-up in demand caused by weakening in the rolls. Rolls are expected to deteriorate further in these coupons as Treasury sells their holdings.
Mortgage banker selling averaged $1.1 billion per day compared to $1.5 billion in the previous week. Supply over the Friday through Thursday picked up from $0.6 billion to $1.7 billion, however. Volume remained below normal with Tradeweb averaging 84% for the week through Thursday, in line with the previous week's average.
MBS performance for the week was mixed with Barclays Capital reporting its MBS Index by Wednesday was underperforming Treasuries by 60 basis points from -31 basis points on the previous Friday.
By Thursday's close, however, it had recovered to -41 basis points, but continued to lag ABS (negative five basis points), CMBS ( negative 11 basis points) and Corporates (12 basis points). The 30-y CC yield decreased to 3.89% from 3.95% with the spread a basis point wider to both 10-year notes and 10-year swaps to 94 and 80 basis points over, which are near their wides of the year.
Refi Legislation Talk Resurfaces
Higher coupons were pressured on another round of legislative talk, this week being the Boxer Bill. Senator Barbara Boxer (D-CA) held a press conference to discuss a bill she introduced in January called S. 170 Helping Responsible Homeowners Act of 2011.
Her bill would eliminate risk-based fees on loans for which the GSEs already bear the risk; remove refinancing limits on underwater properties; make it easier for borrowers with second mortgages to participate; and require that borrowers receive a competitive interest rate comparable to other borrowers in good standing that have not suffered a drop in their home values and stayed current in their payments. Boxer said that an estimated two million homeowners would benefit and that there would be 54,000 fewer defaults by homeowners.
Given that previous bills have been unsuccessful, this bill is not expected to get much traction either — especially as the House is now controlled by Republicans. Most analysts say it has a slim chance of passage in its current form.
Prepayment Outlook
The initial prepayment outlook is for 30-year speeds to increase less than 5% on average, with the largest percentage increases in 4.5% and moderately seasoned 5% coupons.
At this time, speeds are expected to peak in August with the day count a significant influence at 23 days from 21 in July and helping to push speeds up nearly 10%. The increase is projected to reverse in September as the number of collection days falls back to 21.
