MBS mostly lagged in both rallies and sell-offs this week. Having the 10-year note yield in the 2.0% area raised concerns among both real investors and fast money accounts about increased originator supply and convexity-related selling. Higher prices on bouts of risk aversion weren't palatable either.
One significant influence to this week's performance was dollar roll weakness in 30-year FN 3.0 and 3.5s into Class A pool allocations on Friday. The Feb/Mar 3.0 roll declined to 067/07 by early afternoon from 093/09+ as of last Friday, and the 3.5 roll to 046/052 from 076/077. Many rolled early, including the Federal Reserve, which was a factor as investors apparently sought to avoid "a debacle" like last month, when rolls heated up.
Some other influences that have pressured the basis are low bank demand and high dealer holdings in MBS. Bank demand has been muted despite the 30-year current coupon yield increasing towards 2.60% from 2.30% at the start of the year. This muted demand has been attributed primarily to a significant decline in deposits. Citi mortgage analysts think that banks may limit their activity in MBS over the near term to reinvestment of paydowns, while Credit Suisse expects bank demand should come back when the market is more stabilized in terms of a rate range. Meanwhile, dealer holdings in MBS are near all-time highs, said Citi.
Although supply/demand technicals generally remain supportive in the near term, investors may also have started to peer ahead to when the Fed begins to wind down its asset purchases. That could possibly occur by or before the end of this year. This expectation is fuelled in part by the January FOMC minutes, which included discussion on this. Even this week the dovish leaning Chicago Fed President Evans alluded to the potential for early exit in comments that Fed could stop buying before the unemployment rate reached 7.0% and that asset purchases are likely to continue through "much" of the year. Wall Street research certainly is starting to estimate what the potential spread and price impact might be on the lower end of the coupon stack and it isn't pretty.
January prepayment reports, which were released late Wednesday afternoon, had very minimal impact on trading. Speeds were little changed from January, on average, and mostly in line with expectations. As for the outlook for February, a lower number of collection days will contribute to a modest slowing in speeds with the largest percentage declines in lower coupons where higher mortgage rates have lowered the incentive to refinance. Speeds on HARP cohorts, however, are expected to remain elevated.
Performance for the week through Thursday on Barclays’ MBS Index was down 14 basis points, which pulled the month to date tally to down 5 basis points. The 30-year current coupon also widened, to about plus 60 basis points versus 10-year notes, from plus 56.5 basis points as of last Friday. Volume was slightly below average, at 97%, according to Tradeweb, compared with120% last week. Activity was boosted by the FOMC statement and employment report.
Selling from mortgage bankers averaged $2.5 billion per day, with supply becoming more evenly split between 30-year 3.0s and 3.5s versus mostly 3.0s in the past few weeks. The Fed followed the supply trend with its purchases of 30-year 3.5s increasing to 11.1% from 8.2%, while 2.5s dropped off to zero from the 3.0%-area. For the week ending February 6, net MBS purchases totaled $18.4 billion, or an equivalent of $3.7 billion per day.
Fed demand technicals are expected to slip in the four-week period that begins February 13 as paydowns were slightly lower in January. For the previous three months, the Fed's buying through paydowns received on its Agency MBS and debenture holdings has been between $34 billion and $35 billion. The New York Fed will announce its buying estimate for the new period on Tuesday, February 12.
In other mortgage-related activity, 15s outperformed 30s as they benefited from less extension risk and GN/FNs were mostly higher. One source of strength for Ginnies has been the Fed as its Ginnie purchases have held in the 30% area for the past three weeks, up from 20% to 25% before.
Meanwhile, specified pools struggled with too much supply and not enough demand. Originator BWICs were heavy with Class A approaching, while lists from private investors were prevalent as well. With rolls generally strong in lower coupons, real money interest is lacking. The imbalance has led to payups being pressured lower, spreads wider and yields higher; however, this should eventually start to draw interest.
Finally, there were headlines this week that potentially could lead to even higher speeds on HARP-eligible borrowers and higher coupons were a bit shaken in the latter part of the week by the news. One is the re-introduction of The Responsible Homeowner Refinancing Act of 2013 from Senators Menendez and Boxer; the other is a letter to President Obama signed by 45 House Democrats urging him to replace acting FHFA Director DeMarco.