Mortgage market activity was steady and two-way last week ahead of Thursday's Federal Open Market Committee statement. There was some early week support from index funds for month-end. Lehman Brothers stated that the MBS Index is set to extend a modest 0.06 years last Friday. Overseas and real money investors were also better buyers mid-week as yields backed up.
There was short covering in 5s as well, which held up the coupon rather well despite expectations of better selling at the start of the week, following the Bank MBS Holdings report from the Federal Reserve released June 24 (see story p. 15). The holdings report showed large banks sold $64 billion in MBS - which JPMorgan Securities called the largest monthly drop in holdings ever - and has led to a lot of head scratching by analysts and traders.
This decline along with the increase in net dealer holdings suggests the Street is long a good amount of MBS, said one analyst. RBS Greenwich Capital analyst Alec Crawford said he does not believe banks sold a large chunk of MBS recently. Instead Crawford believes that reporting quirks are responsible for the large drop - many large banks apparently report their holdings on a settlement basis to the Fed - adding that more than likely, the data reflects an up-in-coupon trade with staggered settlements. In this case, Crawford suggests, banks could have taken gains on their 5s before quarter end and reduced their balance sheet size without a massive drop in MBS exposure. More about this should be known after July settlement, Crawford added.
With the late week rally in rates for the week ending June 24, mortgage bankers were kept fairly busy over the weekend. Originator selling did pick up and averaged close to $1.5 billion per day. Most of the supply is coming in 5% coupons.
Analysts last week remained split, with many recommending a slight underweight and others a slight overweight. JPMorgan analysts, for instance, said that they remain negative on the basis. "Bank and GSE selling will eventually take their toll, especially with the Fed continuing to tighten," JPMorgan analysts wrote. Bear Stearns also turned slightly negative on mortgage spreads, citing concerns about the large bank holdings drop and the increase in dealer inventories. Bear believes this is a potential weakening in the technical picture, and combined with tight OAS's and limited GSE demand "stacks the deck against mortgages." UBS, meanwhile, is holding with its modest overweight to mortgages. Analysts believe mortgages are attractively priced, and expect buying will pick up after quarter end.
Last week, mortgage application activity held steady. The Mortgage Bankers Association reported that the Purchase Index was essentially unchanged at 477 versus 479, while the Refinance Index was down less than 2% to 2529. While a slowing was seen earlier in the week, activity actually picked up later in the week as the market rallied.
As a percentage of total application activity, refinancings were essentially unchanged at 45.4% versus 45.6% previously. ARM share fell to 30% from 30.7%. "The ARM share of applications, at 30%, is at its lowest level since April of 2004," said Michael Cevarr, MBA's director of member surveys. "At the same time, the 30-year fixed mortgage rate declined to its lowest point since March of 2004."
Fixed mortgage rates decline
Freddie Mac reported a mixed survey with fixed mortgage rates declining slightly, and adjustable rate mortgages increasing one basis point. Last week, both the 30- and 15-year fixed mortgage rates fell four basis points to 5.53% and 5.12%, respectively. The 30-year remains at its lowest level since early spring 2004. Freddie Mac also reported that 5/1 hybrids and one-year ARM rates increased just one basis point to 5.06% and 4.24%, respectively.
Looking ahead to this week's application activity report, the Refinance Index is expected to hold in the mid-2000s, although a modest increase to over 2700 would not be unexpected as application activity in the previous weekend seemed busy.
"With still little or no threat of inflation to be found, long-term mortgage rates this week had some breathing room, and that allowed rates to drift a little lower," said Freddie Mac's Chief Economist Frank Nothaft. "Short-term rates, though, may be another matter, since the Federal Reserve is expected to continue raising its target for the federal funds rate at least a few more times this year."
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