Last week had a heavy data calendar, along with some earnings news from key MBS players. Data in the first half of the week generally came in worse than expected. For example, the PPI numbers were much stronger than expected at 1.1% versus a consensus call for 0.5%, and year-over-year was at 6.9%, up from 6.4% in February. Bear Stearns' economists noted that inflation was everywhere in the report. The Federal Reserve's Beige Book also reported widespread pricing pressures for food, fuel and energy, and many raw materials. In addition, it cited some wage pressures showing. The combination has lowered the odds of a 50-basis-point cut in the Fed Funds rate at the end of the month to 25 basis points currently.
March housing starts fell a larger-than-expected 11.9% to 947,000, their lowest level in 17 years. Meanwhile, February starts were revised higher to 1,075,000 from 1,065,000. Analysts had predicted a decline to 1,018,000. Building permits also fell a more-than-expected 5.8% to 927,000 versus a median estimate of 965,000. The news does not help the outlook for GDP for the second quarter.
The earnings news was mixed. Wachovia surprised the market with a first-quarter loss of $0.20 per share. Consensus had anticipated a positive $0.40 per share. The loss came on another $2 billion in write-downs and $2.1 billion in loan loss provisions. As a result, the bank said it would raise $7 billion in new capital as well as cut its dividend. JPMorgan and Wells Fargo reported substantially reduced net income results versus a year ago. However, it was less than analysts were projecting. Washington Mutual also reported a loss, although it was less than expected.
MBS volume through midweek was below normal on average, resulting from a lackluster session on Monday and attributed primarily to looming key data later in the week. Flows at the start of the week were mixed with servicers buying in both the 30- and 15-year sectors, while hedge funds were better sellers in 5s and 5.5s, both outright and versus Treasurys and swaps. Tuesday and Wednesday were a bit more normal as far as volume. Servicers became better sellers on Tuesday, particularly in the lower part of the coupon stack as Treasurys sold off sharply on the stronger-than-expected PPI news. In the afternoon, however, money managers started buying, which more than offset the morning's servicer activity. Flows continued to favor up in coupon on Wednesday; however, mortgages lagged sharply as Treasurys sold off sharply, volatility jumped and swap spreads widened. The 10-year Treasury closed off over a point on Wednesday with the yield rising to 3.70%.
In addition to the better-than-expected earnings news from JPMorgan and Wells Fargo that took money out of bonds and into stocks, Treasurys were also hit by the outlook for just a 25-basis-point cut in the funds rate versus 50 basis points at the end of April. Other factors were the issues surrounding Libor and funding rates. Citigroup Global Markets analysts noted recently that "the current liquidity crisis has created a situation where Libor, at times, no longer represents the level at which banks extend loans to others."
Foreign banks and Asian investors were moderately active in the first half of the week. Meanwhile, 15s were finally seeing some better interest after some significant cheapening over the past week or so. GNMA/FNMA swaps were firmer, benefiting from some slight credit fears and strengthening in dollar rolls heading into Class C pool allocations. Specified pools saw good demand on Tuesday from CMO underwriters. Originator selling remained light at a daily average of about $1.25 billion through Wednesday. Supply was focused in 5%s and 5.5%s.
MBS performance remains in positive territory, but it is off from levels experienced earlier this month. Month-to-date through April 15, the Lehman Brothers MBS Index outperformed Treasurys by 14 basis points compared to 52 basis points month-to-date through April 8. Compared with competing spread sectors, MBS was lagging behind the CMBS Index, which was up 55 basis points, and U.S. corporates, which have outperformed by 92 basis points month-to-date. Mortgages were outperforming the ABS Index, which was up 10 basis points so far in April.
MBS analysts' outlook last week was generally neutral on the mortgage basis. The recent improvement in dollar rolls is favorable, as is some better support from overseas investors.
Additionally, RBS Greenwich Capital said mortgages still appear cheap from a longer-term perspective. At the same time, given the strong tightening already since the Bear Stearns bailout, Deutsche Bank Securities analysts said they do not see further substantial improvement in spread product from current levels, but short-term opportunities on spread widening are likely.
Barclays Capital also does not believe they have room to tighten much over the near term and so moved to neutral from positive on mortgages last week. In addition, they noted there is potential pressure looming from first-quarter earnings releases that are getting into full swing now. Still, analysts see downside risks as limited, in part, as the GSEs are in a better position to act as the "buyer of last resort."
In terms of the prepayment outlook, speeds on FNMAs are currently projected to be about 2% higher overall in April, primarily due to increases in the 5% coupon. Higher coupons, in aggregate, appear to be flat to lower. GNMA speeds are forecast higher at up 6% overall. The 5% coupons are also a major contributor to the increase at up 11% overall; however, unlike FNMAs, 5.5% and 6% coupons look to be up 4% to 5%.
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