The June prepayment reports were released late July 6 with speeds faster than expected on 3.5s and 4.0s as the underlying credit-eligible borrowers responded to the successive record lows in mortgage rates that began in early May. At the same time, they were slower than expected in the higher Home Affordable Refinance Progam or HARP-eligible coupons.
This led to better selling down in coupon from real and fast money to move higher, particularly into FNCL 4.5s which surged 10 ticks on Tuesday compared to +2 ticks on 4.0s, +4 ticks on 5.0s and +2+/32nds on 10-year notes on expectations that HARP speeds are near their peaks.
The prospect of QE3 did not come to the aid of production coupons as the Federal Open Market Committee (FOMC) minutes released on Wednesday indicated economic conditions were not ripe yet to engage in additional easing.
"A few members expressed the view that further policy stimulus likely would be necessary to promote satisfactory growth in employment and to ensure that the inflation rate would be at the Committee’s goal," the FOMC said. "Several others noted that additional policy action could be warranted if the economic recovery were to lose momentum, if the downside risks to the forecast became sufficiently pronounced, or if inflation seemed likely to run persistently below the Committee’s longer-run objective."
According to Credit Suisse analysts, as of Tuesday's close the pricing of FNMA 3.5s suggested a 79% QE3 probability, but the "wait and see stance" dropped it to a mid-60s percent probability. In MBS research from BNP Paribas, analysts said their economists expect Chairman Ben Bernanke to build the case for further easing at the annual Jackson Hole conference at the end of August with an announcement at the September FOMC meeting. "This should be supportive of MBS, particularly, lower coupons," they said.
That was for another day, however, as heavy selling in 3.5s and 3.0s from real and fast money ensued with sellers reportedly outnumbering buyers by 5:1. At the same time, originator selling picked up with only the Fed having any appetite for lower coupons. FNMA 3.5s were the worst performing coupon on the stack with the spread 3-4 ticks wider to Treasuries and swaps, while higher coupons were tighter by around 1/8 point.
Between the selling and supply and limited demand, lower coupons opened Thursday wider and were pressured further into mid-morning on more originator selling, especially 3.0%s as supply was more concentrated in this coupon. The widening, however, drew money managers and hedge funds back into the production coupons as did lower prices on Friday.
In other mortgage-related activity, dollar rolls reacted to the prepayment news, particularly the FN 4.5 roll which spiked around 7 ticks to over 10 on Class A 48-hour day in part on the improved HARP outlook. Specified trading, of course, remained active with payups strengthening on the demand from REITs, banks, money managers and CMO desks for call protected paper. GN/FNs were mixed with lower coupons higher and fuller coupons lower.
Mortgage banker selling for the week averaged $2.0 billion per day which was ~60% covered by the Fed which held to a daily average pace of $1.2 billion. Tradeweb volume through Thursday averaged 88% compared to 77% last week. Excess return on Barclays' MBS Index totaled three basis points with MTD at +10 basis points.
The 30-year current coupon yield declined 10 basis points to +2.45% with the spread to 10-year notes four basis points tighter to +97. For the record, there were more records set during the week in mortgage market.
Prices on 30-year FNMA 3.0s through 4.5s set new price highs of 103-24, 106-01+, 107-02 and 108-06 on July 10.
Meanwhile, mortgage rates set new historical lows with the 30-year fixed rate at 3.56%.