The wait for the Federal Open Market Committee's (FOMC) statement on Wednesday afternoon kept mortgage volume below normal in the first half of the week.

Flows were mixed, although tilted toward better selling. Asian investors were a light two-way presence, focused primarily in 5.5% coupons. Money managers sold lower coupons to move up in coupon, while the longer-type investors like pension funds and insurance companies bought in the lower half of the coupon stack.

Volume picked up following the FOMC's statement, which was generally in line with expectations. The Federal Reserve left the Fed Funds rate unchanged at 2% but was more hawkish, noting that "uncertainty about the inflation outlook remains high."

The Fed believes downside risks to growth remained but had diminished, while "the upside risks to inflation and inflation expectations have increased." The Fed also reiterated its stance to act as needed to promote growth and price stability. MBS spreads improved following the Fed with buying picking up in the lower part of the stack, pulling those spreads tighter to the curve and swaps. Volatility also dropped sharply while swap spreads tightened - further benefiting MBS.

In other mortgage-related activity, specified trading was fairly quiet: 15s underperformed 30s, while GNMA/ FNMA swaps were steady to slightly higher. Supply was very light, averaging less than $1 billion per day through Wednesday.

As June heads out, mortgages look to report a losing month. Lehman Brothers MBS Index is lagging Treasurys by 78 basis points through June 24. This compares to negative 98 basis points for CMBS, negative 70 basis points for U.S. credit and negative three basis points for ABS.

Mortgage Outlook

Analysts were mostly neutral on the mortgage basis last week. JPMorgan Securities recommended investors stay neutral on the basis, as they expected it to remain directional with rates, tightening on strengthening and weakening on sell-offs.

Analysts expressed concerns, however, on the narrowing in swap spreads rather than widening on convexity hedging. They believe servicers have used primarily passthroughs for hedging rather than swaps and options. JPMorgan analysts don't believe the narrowing in swap spreads can be sustained, and this is a risk for mortgages.

They also noted the increase in dealer MBS holdings in the past couple Fed reports. As of the close of June 11, net outright positions totaled $62.2 billion, up nearly $11 billion in the previous two weeks. They expect dealer deleveraging and diversification will continue - which will weigh on mortgages - although they believe the process will be a gradual one.

Barclays Capital analysts also held a neutral stance on the basis despite its cheapness. They expect volatility to remain elevated over the near term, supply to be high with deleveraging an additional weight and demand to be uncertain from banks and broker/dealers given their poor earnings.

Analysts also bring up the potential risk of duration shedding at some point as prepayment models get adjusted slower for the current market conditions and outlook.

Refi Index at Lowest Since 2001

Mortgage applications declined in response to the higher mortgage rates, along with the weak housing market and tight lending standards. Overall, activity fell 9.3% to 461.3.

The Mortgage Bankers Association (MBA) reported that the Refinance Index dropped 12.1% to 1212.2. This is the lowest since mid-July 2001, when the index was at 1200 with the 30-year fixed mortgage rate at 7.19%. A year ago the Refinance Index was at 1732 with rates at 6.69%. The Purchase Index was 7.4% lower to 333.4 compared to 429 a year ago.

According to the MBA, the 30-year fixed contract rate eased 18 basis points to 6.39%. The one-year ARM contract rate fell 13 basis points to 7.09%.

As a percent of total applications, refinancings were 36.3% compared to 37.4%. ARM share was also lower to 8.5% from 9.7%.

So far this month, the Refinance Index is averaging 31% lower than May's average, with the 30-year fixed rate averaging 25 basis points higher. Current expectations have speeds slowing 3% to 4% in July and August.

Prepayment Outlook

Speeds are seen slowing 4% to 5% on average in June and by 3% to 4% in July and August due to the sharp slowing

in refinancing activity. The MBA's Refinance Index averaged just 2036 in May, down 15.6% from April's average.

The slowing in refinancing activity is due primarily to the poor housing market and tight credit standards. Steadily climbing mortgage rates, lower consumer confidence and higher mortgage fees that the GSEs instituted on June 1 are also contributing factors.

June factor reports will be released July 7. Pay-downs are estimated in the mid-$40 billion area.

Mortgage Indexes

FH 30Yr

Fixed

Wk Refi Purchase Mortgage

Ending Index Index Rate

06/20/08 1212 333 6.42%

06/13/08 1379 360 6.32%

06/06/08 1622 376 6.09%

05/30/08 1496 337 6.08%

05/23/08 2014 353 5.98%

05/16/08 2211 353 6.01%

05/09/08 2422 379 6.05%

05/02//08 2274 381 6.06%

04/25/08 1905 340 6.03%

04/18/08 2286 357 5.88%

04/11/08 2866 382 5.88%

04/04/08 2725 385 5.88%

03/28/08 2636 356 5.85%

A Year Ago 1732 429 6.69%

Sources: MBA,FHLMC

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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