There was plenty of activity in the mortgage sector last week. Banker selling picked up and averaged about $2 billion per day. About 80% of the supply was in 30-year 5.5s and 6s, and the remainder in 15-year 5s. Offsetting supply was good buying from money managers and banks, primarily in the lower end of the coupon stack.
Over the Wednesday-to-Wednesday period, spreads were one and two basis points wider in 30-year Fannie Mae 5.5% and 6% coupons, respectively; and two and five basis points weaker in dwarf 5s and 5.5s. Higher coupons in both sectors moved out 10 basis points or more.
Ginnie Mae spreads, meanwhile, widened about a basis point more than conventionals after better performance over the past couple of weeks due to Fannie Mae's wide duration gap. On Tuesday, Oct. 1, Fannie Mae reported ahead of schedule that they had reduced their gap to -10 months from -14 months. Responding to the report, Lehman Brothers noted that the lengthening was quite remarkable given that the MBS Index shortened by five months over this period.
PIMCO's outlook
Based on the recent economic news, odds are at about 90% that the Fed will cut rates 25 basis points at its Nov. 6 meeting. What effect will this have on mortgages? Last week, Pacific Investment Management Co.'s Bill Gross discussed this issue in his quarterly Investment Outlook. He said that mortgage rates will not follow Fed Funds point-for-point lower if the Fed cuts rates because the extension and negative convexity risk will be too much for investors. "There will never be much less than a 5% 30-year GNMA, Freddie Mac, or FNMA mortgage issued in size no matter what Greenspan does," Gross said. "And that's a forecast you can take to the bank, with a high probability outcome. No investor in their right mind would be on the buy side of a 30-year mortgage with a 4% coupon and a potential extension from a 5-year, to a 12-[year], to an 18-year average life staring them in the face."
Mortgage indexes
The Mortgage Bankers Association reported a new record high for its Refi Index for the week ending September 27. The Index gained 12% to hit a new record high of 6671, beating the previous record set in early September by over 500 points. Responding to the surge after weeks of just modest gains considering the level of mortgage rates, Lehman suggested the jump in the index seems to indicate that capacity constraints at the mortgage bankers are easing up.
In other news reported by the MBA, the Purchase Index was unchanged at 359; ARM applications as a percent of total applications increased to 12.5% versus 11.3% in the previous release; and last, refinancings represented 76.9% of total applications compared to 74.8% in the last report. The record is 78.4%, set in November 2001.
Freddie Mac reported that mortgage rates were mixed, though little changed, for the week ending Oct. 4. The 30-year fixed mortgage rate rose two basis points from its record low to 6.01%, while the 15-year fixed mortgage rate moved one basis point lower to 5.40%, a new record. Last, ARM rates were higher at 4.29%, versus 4.22%.
Looking ahead, Lehman expects the Refi Index to stabilize at around 6500 at current market levels. At these levels, Lehman has revised higher its expectations on 2001 6s and 6.5s to 50% CPR and 62% CPR, respectively.
Prepayment outlook
On Monday, the housing agencies release prepayments covering the month of September. Expectations are for Fannie Mae 2001 6s, 6.5s, and 7s to prepay at 28% CPR, 52% CPR, and 60% CPR, respectively. This compares to 18%, 38%, and 47% in August. 2000 7.5s are predicted to prepay at 64% versus 60% in August.
For Ginnies, speeds on 2001 6s, 6.5s, and 7s are forecast at 19% CPR, 43% CPR, and 58% CPR, respectively, versus 13%, 32% and 48% in the previous month. 2000 7.5s are expected to increase to 63% CPR from 56%.
