Mortgages slightly outperformed through Thursday as investors took advantage of cheapening that occurred in the early part of the week.

Volume, however, was modestly below normal at a 91% average compared to 97% last week. 

Tuesday turned out to be the most eventful trading session for the mortgage market. A contributor was Class A (30-year conventional MBS) notification as dollar rolls spiked based on higher coupon FNMAs. This is particularly true for 4.5s and 5.0s where the street was short. Gold rolls were also lower.

The notification contributed to spread support through the morning. However, a flight-to-quality rally on continued eurozone and global growth worries pushed the 10-year note yield below 2.0% for the first time since early March. This then led to a jump in originator supply as well as profit taking from banks, money managers and hedge funds totaling over $4 billion on Tuesday afternoon. Spreads shifted from tighter to 2-4 ticks wider with lower coupons lagging the most.

The tone was more supportive over Wednesday and Thursday as supply/selling-induced cheapening followed by price weakness on Wednesday and Thursday due to longer-term Treasury supply (10-year note and 30-year bond auctions) and reduced risk aversion drew in buying interest from REITs, money managers, banks and hedge funds. However, volume was still modestly below normal.  Into mid-morning on Friday, volume appeared limited on Tradeweb as markets turned risk averse because of China growth and European Union worries. With the 10-year note yield back through 2.0%, there was better selling as well with spreads flat to weaker to the curve and swaps with higher coupons lagging lower ones.

The Federal Reserve, of course, maintained a steady appetite for MBS at a $1.4 billion-per-day average that covered 70% of the estimated mortgage banker supply over the week. The $1.4- billion-daily average is expected to be maintained in the April 12 through May 10 period as the Fed estimates MBS purchases over this period to hold at $29 billion. 

The official buying continues to provide a very strong technical support against originator selling that has been running at a daily average of $2 billion for several weeks, including this one. 

Reinvestment of paydowns is expected to continue for the foreseeable future as, based on recent comments from various Fed officials, the agency is not ready to abandon its accommodative stance. It is also not at that point where stopping its reinvestment in mortgage paydowns back into agency MBS would cause a tightening. 

At the same time, however, many economists are not expecting the Fed to start another round of quantitative easing unless there is an adverse change in the economy's direction. Additionally,  the picture painted by this week's Beige Book remains upbeat.

According to the report, all Districts demonstrated some level of expansion ranging from a "modest" to "moderate" pace. The major areas of the economy recorded gains, even real estate, which showed "some improvement", primarily through the expansion in construction of multifamily housing. But, one area of concern for many sectors of the economy was increased energy prices. 

In other mortgage activity, 15s lagged 30s in the latter half of the week despite a steeper curve, while GNMA/FNMAs were little changed in the production area of the stack and lower on 4.5s and 5.0s.

Of specific interest, Wednesday saw the first pools of 125+ LTVs from Citigroup and Wells Fargo traded, totaling $465 million. They were reportedly well bid and had good interest from money managers, REITs and primary dealers.

There were also more BWICs of these CR (FNMA) and U9 (FHLMC Gold) pools totaling over $700 million on Thursday. Settlement is in June, which is when pooling of these high-LTV loans begins.

Prepayment Outlook

The 30-year FNMA MBS prepayment speeds are expected to be lower by 5% on average with 3.5s through 4.5s slowing around 10% because of a lower number of collection days at 20 from 22 as well as  lower refinancing activity.

Meanwhile, higher coupons are expected to experience more of an impact from HARP 2.0, especially as the GSEs' automated underwriting systems are fully upgraded now for the November changes. 

Looking further out to May, speeds are projected to be flat on average while June is expected to be slightly lower. The lower coupons are estimated to be slower while the higher coupons are flat to slightly higher.   


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