On Monday, the Federal Reserve Bank of New York announced that it had begun purchasing fixed-rate agency MBS.
Mortgages rallied sharply over the course of Monday and Tuesday as the Fed bought several billion in 4% to 5% coupon MBS and primarily in FHLMC Golds.
This encouraged foreign bank buying in 4.5s through 5.5s with GNMAs favored, while banks, hedge funds and money managers took advantage of the pop in prices to take profits all along the coupon stack. Flows were more two-way on Wednesday with early morning profit taking sending spreads wider initially.
Spreads firmed a few ticks beginning mid to late morning as the Fed started buying and other investors took advantage of the brief cheapening. Originator supply was very limited in the first half of the week at just over $1.5 billion on average per day.
Mortgage performance was off to a positive start for 2009 with the Barclays Capital MBS Index outperforming Treasurys by 91 basis points in the first three trading sessions. This compared favorably to ABS, which was underperforming by six basis points, while CMBS and corporates were doing slightly better with excess returns of 106 and 100 basis points, respectively.
Housing and Economic Outlook Worsens
While MBS is benefiting from the Fed program, it will likely be a while before it filters down into the housing market. One stumbling block is the reappraisal requirement for refinancing loans, as the value of many borrowers' homes is below what they owe. Eliminating this requirement could allow many borrowers to refinance their mortgages at a more affordable mortgage rate and help prevent foreclosures.
Of course, the worsening economic outlook and rising unemployment are making it difficult for people to consider the purchase of a new home despite historically low mortgage rates and improved affordability due to the plunge in home prices.
In fact, the National Association of Realtors' (NAR) Chief Economist Lawrence Yun named mounting job losses and weak consumer confidence as contributors to the larger-than-expected 4% decline in the NAR's Pending Home Sales Index for November to 82.3, while October was revised downward to 85.7. Compared with a year ago, the index is down 5.3%. As these issues are ongoing, Yun expects December's housing activity will likely be lower despite the improvement in mortgage rates.
Minutes from the Fed's December Federal Open Market Committee meeting also highlighted a worsening outlook with the committee's new projections showing Real GDP falling much more sharply in the first half of 2009 than previously expected, followed by a slow recovery in the second half of the year. For all of 2009, the committee forecasts Real GDP to decline. The Fed's outlook for unemployment was also revised higher from the October meeting, expecting the rate to rise significantly into 2010. The only good news reported was the easing of the inflation outlook.
Mortgage Application Activity Dips
Mortgage application activity declined in the week ending Jan. 2 as a result of lower refinancing activity. The Mortgage Bankers Association (MBA) reported that the Refinance Index fell 12.3% to 5904.5, while the Purchase Index rose 7.3% to 344.2.
The slowing in refinancing activity despite a more favorable interest rate environment was related in part to the distraction of the New Year's Day holiday. In addition, activity is likely being impacted by the ongoing tight underwriting environment and the steep decline in home prices, which make it difficult for many borrowers to refinance. Also, borrowers could be waiting for better mortgage rates, which are expected with the Fed buying.
The MBA also reported a slight increase in mortgage rates with the contract rate on 30-year fixed mortgage rates increasing four basis points to 5.07%. The one-year ARM rate, however, dipped 25 basis points lower to 5.90%.
As a percent of total applications, refinancing share slipped to 79.8% from 82.9%, while ARM share increased to 0.9% from 0.8%.
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