Performance gains in December have been mediocre, with Lehman Brothers' MBS Index up just four basis points month to date. In recent sessions, stronger than expected data (nonfarm payrolls and retail sales) have been steadily moving yields mostly higher with one foray lower on Federal Open Market Committee day. Following the weekly claims data on Thursday morning, the 10-year yield was at 4.60% after trading below 4.50% from the end of November until the employment report.
Mortgage flows over the week were fairly active and two-way. Ahead of Tuesday's FOMC meeting, mortgage volume was relatively quiet. Flows picked up modestly following their afternoon statement on Tuesday with better buying as the market rallied.
The FOMC statement was pretty much in line with recent ones. However, the committee did acknowledge a slowing in economic growth this year influenced by a "substantial" cooling in the housing market. The day saw some real money and overseas focused up in coupon.
Meanwhile, there was not too much fast money or service presence as the 10-year spiked lower to 4.491%. Tuesday's rally was short lived as a strong retail sales report on Wednesday sent prices sharply lower with the 10-year Treasury price down 22/32nds on the day. Mortgages saw initial support from overseas cheapening, but as Asian buyers went home and the market continued to sell-off, profit taking from domestic investors picked up. Both real and fast money continued to move up in coupon as they shed duration with the move higher in rates. Better buying was emerging in Thursday's session led by active support from Asia.
Originator selling averaged just over $1 billion per day last week. Supply has consisted largely of 5.5% coupons.
Positive Street sentiment
Street analyst sentiment is mostly positive in the mortgage space currently. For example, last week Bear Stearns analysts turned bullish again on mortgage spreads. They said market conditions should favor tighter spreads, helped by expectations that volatility will drift lower and swap spreads will resume their tightening bias after the recent news concerning the closing of a subprime originator. UBS also remains favorable noting that supply tends to be lower at this time of the year, seasonals are positive and foreign demand remains robust. In addition, mortgages are attractive versus alternatives such as corporates and agency debentures. Analysts continue to favor up in coupon.
Barclays Capital was more cautious, taking a neutral stance on the basis. But for two factors, analysts said they would more likely be advocating an underweight, analysts said. For one, analysts believe the front end is unlikely to unwind its implied eases in the near term and that the duration bid is likely to continue. Further supporting these sentiments is weakness in the housing market. This should prevent an abrupt widening in spreads, but they are concerned about the longer-term prospects for MBS. Barclays Capital's initial look into 2007 shows fewer supportive factors for the sector versus in 2006. Analysts do not expect banks to be bidding so strongly in the early part of the year; they also don't anticipate volatility to decline like it did in 2006; further flattening in the yield curve is anticipated. Of course, there is still a risk that the slowing housing market and potential slowing in speeds that could lead to a re-pricing in MBS.
Holiday focus begins
After next week, the market will enter into its "long winter nap" as the holidays move into full swing. There are several economic releases on the calendar, including the third quarter current account on Monday, housing starts, PPI and leading indicators on Tuesday; the final third quarter reading on GDP and Philly Fed on Thursday; and, finally on Friday, there are durable goods and personal income and outlays. Friday also sees an early close leading to a full close on Monday for Christmas. Mortgage flows are expected to remain supportive though volume will steadily decline along with liquidity over the course of the week.
Refinance Index surges
The Mortgage Bankers Association reported a 16% surge in refinancing activity last week to 2304 as borrowers responded to further declines in mortgage rates. This is the highest the Refinance Index has been since September 16, 2005 when it was 2354. Year-over-year, the Refinance Index is up nearly 60%. Meanwhile, the Purchase Index rose 8.7% to 464. The Index is at its highest level since January 2006.
As a percentage of total application activity, the refinance share was 52.6% compared to 50.1%. The refinance share is at its highest level since April 2004, according to the MBA. ARM share rose 1% over the week to 24.9%.
Mortgage rates were little changed this week according to Freddie Mac's weekly survey. The 30-year fixed mortgage rate rose just one basis point to 6.12%, holding at the lowest levels of the year since January. Mortgage rates are down 18 basis points from a year ago levels.
Freddie Mac also reported that 15-year fixed and one-year ARM rates increased two basis points to 5.86% and 5.45%, respectively; while five-year hybrid ARMs were unchanged at 5.92%.
Freddie Mac's Chief Economist Frank Nothaft attributed the limited movement to the mixed economic reports. However, he also said that on the upside, "there was stronger job growth and greater than expected retail sales in November. Offsetting that news was weaker wage growth in that same time frame and lower indications of consumer sentiment in December."
Application activity is expected to remain elevated, helped in part by ARM-to-fixed refinancings. Looking ahead into 2007, Freddie Mac's Nothaft said that mortgage rates are expected to increase modestly next year, though he does not believe they will get to even 7%. This should "help to moderate the current weakness in the housing market," he said.
Speeds in December are predicted to slow around 5% overall with discounts showing larger percentage declines versus premiums. Factors influencing the report include slowing seasonals; however, this is partially offset by a more favorable mortgage rate environment. The 30-year fixed mortgage rates averaged 6.24% in November, down 12 basis points from October's average, while the Refinance Index averaged nearly 8% higher. In January, speeds are seen holding fairly steady from December - helped by one extra collection day. Slowing in the 5% area is anticipated in February which sees a lower day count at 19 versus 21.
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