Last week saw active two-way flows both before and after the Federal Open Market Committee's statement. Investors were fairly confident about what the Fed would say and took advantage of the prospect of curve steepening and lower volatility following the announcement. The market was not disappointed as the Fed did exactly as expected. It kept the rate hike to 25 basis points and retained the "measured" language. The Fed did, however, allow that it could become more aggressive if required, though at the moment it doesn't perceive the need. Given the Fed's language and four more meetings left for the year, it would seem the Fed Funds rate would end the year at 2.25%. Many economists, however, predict a 2.0% level giving into 2005.
Also providing a supportive bid for mortgages was the very large extension in the mortgage index for July 1. According to Lehman Brothers, the MBS Index was expected to extend 0.18 years - substantially higher than the historical average of 0.12 years. Meanwhile, Treasurys extended by 0.02 years, agencies contracted by 0.24 years, the Credit Index extended by 0.04 years and the Aggregate extended by 0.04 years. Also beneficial to the mortgage sector were changes in the Lehman Indices. This is the removal of smaller corporate and ABS issues that will slightly increase the mortgage portion of the index by 1.2%.
Over the week, 30-year Fannie Mae 4.5s, 5s and 6.5s tightened three basis points, while 5.5s and 6s were better by one basis point. In 15s, spreads were three, two and one basis point firmer in 4s through 5.5s, respectively. Buyers over the week included indexers, banks and money managers. Originator selling was somewhat greater than recent weeks at slightly over $1 billion, mostly in 30-year 6s.
A continued supportive tone is anticipated for mortgages in the near term. Analysts were more neutral last week, but are likely to be more positive after events anticipated at the end of the week - assuming there is no surprise in the nonfarm payrolls report. Analysts at UBS said last week that they were holding with their neutral recommendation because of the risk of a short-term rise in volatility. After the occurrence of near-term event risk - FOMC meeting, Iraqi handoff, unemployment report, month- and quarter-ends - analysts plan to re-evaluate mortgage exposure. However, they are more inclined to increase rather than lower mortgage exposure.
Bear Stearns said that with longer interest rates expected to remain relatively stable for the next three to six months, income should be the better part of total return. That makes a good market for selling options, such as through MBS or agency callable debt. As a result, says Bear, "portfolios should do well by raising exposure to these sectors."
Mortgage application activity falls
As expected, the Mortgage Bankers Association (MBA) reported a modest decline in application activity for the week ending June 25. The Purchase Index fell 4% to 435 and the Refinancing Index was down 5% to 1387. As a percentage of total application activity, refinancings were unchanged from the previous report at 33.4%. ARM share increased slightly to 33.9% from 33.5%.
Freddie Mac reported a slight decline in fixed-rate mortgage rates for the week ending July 2. The 30-year rate fell to 6.21%, down four basis points from last week. At the same time, the 15-year rate slipped two basis points to 5.62%. On the other hand, the one-year ARM rate rose six basis points to 4.19% and is at its highest level for the year, nearing levels seen in mid-December 2002.
Looking ahead to this week's mortgage application survey, JPMorgan Securities anticipates the Refi Index will be down another 5%, due in part on expectations that Friday's activity would be light heading into the Fourth of July weekend.
Given current levels on the Refi Index, speeds on 30-year Fannies are expected to decline about 20% to 30% in the June report, which will be released following the market's close on July 7. Consensus anticipates speeds to drop another 20% in July and around 10% to 20% in August.
BMA's outlook on
the housing market
In a recent survey, the Bond Market Association (BMA) said it expects the FOMC to continue to raise rates through 2005. By year-end, the BMA anticipates the Fed Funds rate to be at 2%, and to be at 3% by the end of June 2005. As for mortgage rates, the BMA is predicting 30-year fixed-rate mortgages to average 6.6% by December, and to average between 6.7% and 6.8% for the first nine months of 2005. The forecast is for the housing market to hold firm in 2005, due to strong economic growth (4.7% GDP), and for interest rate levels to remain attractive. Housing starts, for example, are estimated to reach 1.9 million in 2004 and 1.8 million in 2005. New-home sales are expected to hold steady at 1.1 million in 2004, similar to 2003 levels, and dip to 1.0 million in 2005. Existing-home sales are expected to hit 6.2 million this year, up from 6.1 million a year ago. In 2005, the BMA estimates existing-home sales to slow to 5.8 million.
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