Mortgages experienced heavy two-way flows last week. Supply held steady at about $8 billion, similar to the previous week's levels. However, about a third of the supply consisted of 15-year MBS. Money managers, arb accounts, banks, and CMO desks remained strong buyers of the sector, especially in 30-years. In fact, demand more than matched supply.

The previous week's richening in higher coupons was reversed this week, with investors taking profits and moving down in coupon. Interest in the 15-year sector remained mixed despite many factors in its favor, and with the larger supply this week, the sector lagged. Spreads widened about five to seven basis points on the supply and Treasury rally.

The Mortgage Bankers Association (MBA) announced that its Refi Index fell 13% to 4580 on a seasonally adjusted basis, and the Purchase Index fell 8% to 264. Unadjusted, the Refi Index fell just 3% while the Purchase Index rose 2%. Refis as a percent of total applications remained near record levels, falling only 1% to 75.5%.

Freddie Mac also announced that fixed mortgage rates continued to creep higher. Thirty-year fixed mortgage rates gained three basis points to 6.64% and 15-year fixed mortgage rates gained four basis points to 6.13%. Over the last two weeks, 30- and 15-year fixed mortgage rates are six and seven basis points higher, respectively. One-year ARM rates fell one basis point to 5.25%.

With rates slightly higher, the MBA's Refi Index should hold relatively steady. At this time, Lehman predicts the Refi Index to average 4800 over the next few weeks.

Next week is month-end and the sector should see the addition of index buyers. Overall, buying from banks, money managers, CMO desks, and others should continue due to their attractive yield versus the steep yield curve, good liquidity, and excellent quality. With the strong expected demand, supply should be readily absorbed.

Prepayment outlook

mixed on Ginnie Maes

The Street is somewhat mixed on the upcoming Ginnie Mae report. For example, Lehman Brothers predicts 30-year Ginnie Maes to record their greatest percentage increases in the October report, followed by modest gains in November.

UBS Warburg, on the other hand, expects more moderate increases in October, followed by slightly smaller gains for most vintages in November. The difference is primarily due to the recent performance in the MBA's Conventional and Government Refi Indexes.

Since Sept. 7, the Conventional Refi Index has surged 151% versus 47% for the Government Refi Index. While UBS Warburg expects the Government Refi Index to make some gains, they believe the "window of opportunity" is essentially closed for any prepayments to be reflected in the October report. As a result, they expect more muted gains in the upcoming report with sharper gains in the November report.

The housing agencies release their respective prepayment reports covering the month of October on Wednesday, Nov. 7.

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