Some factors started to challenge the strength of MBS' QE3 over the week including better-than-expected economic data and some items in the January Federal Open Market Committee (FOMC) meeting minutes.
While odds were holding in the 40% area following the Fed release on Wednesday, market participants seemed less sure following more encouraging economic reports on Thursday and were reportedly lightening up their "QE positions".
Still, mortgages performed well over the week when all was said and done — albeit in below-normal volume, which averaged 87% for the week compared to 119% in the prior week.
Month-to-date through Feb. 16, excess return versus Treasuries on Barclays Capital's MBS Index was 39 basis points, up 11 basis points from Feb. 10. This compared very favorably to ABS and CMBS, which have gained just three and five basis points, respectively, from the previous Friday. Meanwhile, Corporates lost eight basis points. The 30-year current coupon yield rose to 2.90% from 2.86% with the spread to 10-year swaps tighter to 86 basis points from 89.
Ahead of the FOMC minutes, mortgages benefited from limited supply as Treasury prices rose on risk aversion. QE3 prospects also kept fast money and other investors engaged in the sector, even as 10-year note yields moved away from 2.0% and closer to 1.90%. In addition, there was the Fed that bought at an average $1.2 billion per day over the week ending Feb. 15, which was equivalent to around 70% of the supply over this same time period.
Broad-based selling, however, emerged after the release and continued into Thursday as risk gained some momentum following strong economic news and encouraging reports out of Europe regarding Greece.
Supply also doubled on the sell-off and, while lower and wider, did draw in some opportunistic buying from banks and money managers, it wasn't enough to offset the selling or supply.
On Friday, investors remained cautious. Lower coupons were lagging as buyers took a stab at risk, sending 10-year note yields to over 2.0%, while higher coupons were firmer on better buying in the up-in-coupon trade and, as a result of a steeper yield curve.
In other mortgage-related activity, specified pool trading remained busy with demand for call protected paper with payups holding firm. The 15s were mixed versus 30s with lower coupons underperforming and GNMAs/FNMAs were lower.
QE3 Not Yet Ruled Out
In the latest FOMC minutes, there was a reduction in the support that additional accommodation might be warranted to "a few members" from "a number of members" in the November report.
"While it appears to be becoming less likely the FOMC minutes by no means rule out QE3," Barclays analysts said.
It seems very dependent on the economy, and if there is weakening over the next few months, analysts think it will then be seriously considered, while moderate growth will make it unnecessary.
Employment and state of the housing market have been seen, in part, as motivations for the Fed to engage in QE3.
The former has been more favorable lately with non-farm payrolls increasing more than expected in January with the unemployment rate dropping to 8.3%, while initial claims has been declining steadily to under 400k and in the most recent report was at 348k.
While housing reports have been mixed, more good news is filtering in. For example, last week the National Association of Home Builders (NAHB) reported its fifth straight gain in homebuilder sentiment to its highest level in over four years. Housing starts also rose more than projected in January with December revised upward.
The Mortgage Bankers Association (MBA) also reported further improvement in mortgage loan delinquencies in 4Q11 to a seasonally-adjusted 7.58% rate, down 41 basis points from Q3 and by 67 basis points year over year.
To be sure, the housing market "remains very fragile," said NAHB Chief Economist David Crowe.
Also, the recent robo-signing settlement with state attorneys general is likely to lead to increased foreclosure inventory coming on the market as servicers push through some of the delayed foreclosures from last year, said RealtyTrac CEO Brandon Moore, which will continue to weigh on housing valuations.
Prepayment Outlook
After two months of slowing that was primarily seasonally related, prepayment speeds are poised to increase in February and March with the latter month resulting in a near term peak as speeds are indicated slightly lower in April at this time.
Day count is an influence with February unchanged at 20, March increasing to 22 days, while April drops back to 20. Also impacting speeds in the February and March reports is the increase in refinancing activity in January from year-end. This is given that the MBA's Refinance Index increased nearly 17% on average as mortgage rates dropped to new record lows during the month.
Speeds are currently projected to increase around 6%-7% on average in February from January; March records additional strengthening of 10-15%, while April slows around 5% or less. February paydowns are estimated at $108 billion compared with $104 billion in January while month-to-date issuance totals $66 billion.
