Early-week volume into Wednesday was modestly below normal. This was because the Chinese New Year celebrations kept overseas investors quiet and the market waited for the Federal Open Market Committee's (FOMC) Wednesday statement.
Flows were two-way among money managers, hedge funds and banks, and ranged all over the coupon stack. Meanwhile, the Federal Reserve was a steady presence and focused primarily in the lower part of the coupon stack. Supply remained uneventful, averaging about $1.75 billion per day into midweek, which contributed to the outperformance in the down-in-coupon trade. Dollar rolls strengthened, GNMA/FNMAs were flat to lower and 15s underperformed 30s.
After the Fed's statement on Wednesday, MBS flows remained light with some strengthening in 4s and 4.5s as the 10-year Treasury sold off based on the lack of specifics regarding the Fed's intention to buy longer-term Treasurys, other than that it is prepared to buy them.
The Fed's statement reiterated the likelihood that it would keep Fed funds low for some time as it expects continued weak economic conditions. It noted further deterioration in many areas of the economy, although some financial markets have seen some improvement based on the government's programs to provide liquidity. The FOMC also said it would "employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability." The committee said that it also stands ready to purchase additional quantities of agency debt and MBS above the current stated levels if conditions warrant.
In terms of the purchase of longer-term Treasurys, the Fed is prepared to buy them "if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets."
Month-to-date through Jan. 27, Barclays Capital's MBS Index was outperforming Treasurys by 70 basis points. The sector continued to lag ABS (658 basis points) and Corporates (238 basis points) but was outperforming CMBS (negative 60 basis points).
Housing Reports Remain Dire
Housing news remained discouraging with little to suggest that a turnaround is imminent. The S&P/Case-Shiller Home Price Index for November was down 19.1% year-over-year for the 10-City Composite, matching the previous month's record decline, while the 20-City Composite set a new record low of down 18.2%. The metropolitan areas with the largest annual declines were Phoenix at negative 32.9%, followed by Las Vegas at negative 31.6% and San Francisco at negative 30.8%. The areas with the smallest declines were Dallas at negative 3.3%, Denver at negative 4.3% and Cleveland at negative 5.2%.
For the month, both the 10- and 20-City Composites fell 2.2%. Chairman of the Index Committee David Blitzer observed that the 10- and 20-City Composites have declined for 28 consecutive months now. Phoenix recorded the largest monthly change at negative 3.4%, then Las Vegas at negative 3.3% and Detroit at negative 3.1%. Denver had the smallest decline in November at negative 1.1%.
While existing home sales for December unexpectedly rose 6.5% to 4.74 million units, they followed a downward revision to 4.45 million units in November from a previous report of 4.90 million and came at a cost of sharply lower home prices. The National Association of Realtors (NAR) Chief Economist Lawrence Yun attributed the increase to buyers taking advantage of the much lower home prices. However, he added that "the market is still far from normal balanced conditions." The national median home price was $175,400, down 15.3% from December 2007. Months' supply improved to 9.3 months from 11.2 months. Sales rose in all regions of the country except for the Northeast.
For 2008, the NAR said the median home price was $198,600, down 9.3% from $219,000 in 2007, while existing home sales totaled 4.912 million, down 13.1% from the previous year.
Refi Applications Tumble
The Mortgage Bankers Association reported a 48% plunge to 3373.9 in its Refi Index in the week ending January 23. In that week, Freddie Mac reported a 16 basis points jump in the 30-year fixed mortgage rate to 5.12%, which likely contributed to some of the decline in refinancings. As it has been well telegraphed that the Fed wants to push rates toward 4.5%, borrowers likely will hold off until rates are more attractive again. Barclays analysts also suggested that the 1/2-day seasonal adjustment for the Martin Luther King Jr. holiday may have been too little and added to the noise of the index. Also, the hoopla around the Presidential Inauguration could have played a role in the decline as the nation's attention was focused on that historical event.
The level of the index is the lowest since the Fed announced in the latter part of November that it would begin buying MBS. On the purchase side, applications slipped just 2.9% to 294.3.
As a percentage of total applications, refinancing share dropped to 72.8% from 83.3%. ARM share increased to 2.4% from 1.5%.
As far as prepayments, February speeds are expected to increase close to 50%, while March speeds are projected to be just slightly higher. Given the slowing in refinancing activity because of rate levels, the expected increases could be revised downward.
Last week, Street analysts were mostly positive on mortgages. JPMorgan Securities analysts, for example, turned positive on mortgages versus Treasurys in part on expectations of swap spreads tightening as a result of the surging Treasury issuance.
"The magnitude of Fed purchases and outlook for swap spread tightening make us reluctant to be neutral on MBS for too long," they wrote in a report. They preferred up-in-coupon, particularly into 6.5s, which they believe will benefit from additional increases in g-fees announced by Fannie Mae at the end of December. Supply should also continue to weigh on the lower coupons.
Meanwhile, Barclays Capital analysts continued to overweight the basis. Positives they cited include the Fed and U.S. Department of the Treasury support, attractive funding and valuations on a Libor OAS basis remaining near historically wide levels. On the negative side, they noted supply risks and weaker demand from overseas accounts as suggested by TIC data and foreign custody holdings.
Prepayments are expected to surge in the January report in response to the jump in refinancing activity in December due to the sharp drop in mortgage rates. According to market consensus, speeds are expected to increase 138% on average in 5s through 6.5% - an 11 CPR rise. GNMA speed increases are more moderate at round 50% higher from December. December speeds were much stronger than conventionals, which was attributed to servicer buyouts.
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