MBS activity last week was more active than many thought it would be given the upcoming FOMC meeting, Iraqi hand-off, and the June employment report. The week saw modest two-way flows influenced by the yield curve and volatility. In general, the sector saw a better bid on steepening and lower vol, and better selling on flattening and higher vol. Originator selling held to its recent $1 billion daily average.
Over the week, spreads were two basis points tighter on 30-year Fannie Mae 4.5s; flat in 5s and 6.5s; and one and two basis points wider, respectively, in 5.5s and 6s. Meanwhile, 15s lagged 30s with spreads two basis points weaker in 4s and 4.5s; one basis point wider in 5s, and unchanged in 5.5s.
The topic du jour throughout last week was about volatility and the "meltdown in the swaptions market," as JPMorgan Securities called it. The outlook for vols was a main determinant in Street recommendations for the sector. For example, JPMorgan said it was maintaining its near-term positive view on the market, especially discounts, on expectations that swaption premiums will continue to decline. Bear Stearns sees continued volatility grinding lower primarily due to tepid demand from the GSEs and servicers, and a relatively stable mortgage market. A spike around FOMC would be temporary, analysts added.
UBS, on the other hand, recommends a neutral stance on mortgages from a slightly overweight one as the firm believes that volatility is more likely to rise than fall given its current low level. The near term has several events creating uncertainty for the market, and analysts believe mortgages have little room to tighten further, and could widen. They support their recommendation on the following points: mortgages have done well over the past several months; they are currently slightly rich using a longer regression range; if volatility increases, mortgages are likely to cheapen; and there is a lot of news scheduled for the next week and a half, including month end, quarter end, FOMC, Iraqi handover, and the employment report. Banc of America Securities also warns of a potential spike in volatilities once the Fed starts tightening.
In general, those especially concerned with volatility are neutral on the sector, while those less concerned and believe the longer trend is down remain positive. In addition, carry opportunities are still there and technicals remain very favorable.
Mortgage application
activity holds steady
The Mortgage Bankers Association (MBA) reported overall application activity was little changed for the week ending June 18. The Purchase Index rose 1% to 455, while the Refi Index declined nearly 2% to 1455. This was in-line with expectations. As a percentage of total application activity, refinancings were 33.4%, down from 33.8% in the previous release. ARM share also fell to 33.5% from 34.7%.
Freddie Mac reported a modest decline in fixed mortgage rates for the week ending June 25. The 30-year fixed rate mortgage rate fell seven basis points to 6.25%, in-line with Countrywide Securities' prediction. The 15-year fixed rate dropped six basis points to 5.64%, while the one-year ARM rate remained unchanged at 4.13%.
Given current rates, Lehman Brothers expects both the Refi and Purchase Indices to remain near current levels in the weeks ahead. Countrywide Securities also said recently that if rates remain in the current range of 4.65% to 4.85% on the 10-year, the Refi Index will hold in the 1400 to 1600 range. There is still a large amount of higher-WAC 30-year collateral available that can be refinanced, they said. Researchers calculate that as of May 2004, there were $329 billion in unpaid principal value of loans with a WAC of 6.75% or higher outstanding.
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