Mortgages broke their nine-day losing streak on Tuesday as buyers finally emerged on the cheapening, and sellers took a break as the market moved higher. The better buying continued into Wednesday and Thursday's sessions, despite the looming Federal Open Market Committee statement on Thursday afternoon. Based on Lehman Brother's MBS Index, month to date mortgage performance improved to negative nine basis points (in excess return versus Treasurys) from negative 20 basis points through the close of Monday, June 26.
Investors were primarily moving up in coupon into 30-year 6.5s and 7s given the risks of a slowing housing market. The buying was widespread and came from banks, money managers, insurance companies, hedge funds and servicers. Asian investors, however, remained absent. Alec Crawford, managing director and head of agency MBS strategy at RBS Greenwich Capital, said that the Asian investors that RBSGC traders have talked with have stated that they are interested in investing, but they are waiting until the Federal Reserve is done raising interest rates before committing funds.
There is expectation of better buying following the FOMC meeting, helped by the recent cheapening and potential dip in volatility as some uncertainty is removed from the market. In a report issued last Wednesday, Barclays Capital analysts are recommending a tactical, short-term overweight for these reasons. They add also that MBS prices are at their lowest levels in a while, and that every coupon has cheapened (duration-hedged) over the past month.
They caution, however, that this is just a short-term recommendation as the Fed is expected to keep on raising rates. In fact, Barclays believes the Federal Reserve won't be done until the funds rate hits 6%. Also of a concern is the slowing housing market. A repricing of the market to slower speeds could cause the sector to see a substantial price hit.
David Montano, a strategic principal trader at JPMorgan Securities, noted last week that the average coupon in the MBS market is 5.38%. He believes it is likely that by the end of the summer, this will be below the Fed Funds rate - something that has never happened before. "As a consequence, the investor base is no longer selling volatility but buying the housing market (high turnover)," Montano said. This isn't likely to attract the traditional mortgage investor, he added, and he expects the new marginal buyers will demand competitive spreads and risk premia to compensate for the risk of extension related to a slowing housing market.
Application activity declines on higher rates
Mortgage application activity fell nearly 7% for the week ending June 23, in response to a jump in mortgage rates. The Refinance Index was down 7.5% to 135, while the Purchase Index declined 6.2% to 389, according to the Mortgage Bankers Association's survey,
Thomson Financial's economist, Jeoff Hall, points out that the Purchase Index has risen only once in the last six weeks and is down a net 8.7% since the week of May 12. He added that the Refinance Index ties with the June 2 week as the lowest since the December 23, 2005 week. That index has declined in 15 of the last 22 weeks by a net 24.1%.
Mortgage rates move up another seven basis points
Freddie Mac reported an across the board increase of seven basis points in mortgage rates for the week ending June 30. The 30-year fixed mortgage rates currently average 6.78%, their highest level since May 2002. A year ago, 30-year rates were at 5.62%. The 15-year fixed mortgage rates are currently at 6.39%, up from 5.20% a year ago, and at their highest level since April 2002.
On the adjustable side, 5/1 and one-year ARM rates are at 6.39% and 5.82%, respectively. Freddie Mac noted that one-year ARM levels are at their highest since early June 2002, when it averaged 5.85%.
"Financial markets continue to expect more rate hikes by the Fed over the next six months, which has added upward pressure on mortgage rates," Freddie Mac's Chief Economist Frank Nothaft said. "With higher interest rates, the housing market has begun a gradual and orderly reversion towards historical norms."
With the further gains in mortgage rates, application activity is expected to be lower this week with the Refinance Index moving towards, and possibly through, 1300.
June prepayments on FNMA 30-year MBS are expected to be relatively flat in 5.5% coupons and lower, and slowing about 5% in higher coupons. In GNMAs, speeds are anticipated to increase less than 5% for 4.5s through 5.5s, and hold essentially unchanged in higher coupons. Offsetting favorable seasonals are slightly higher mortgage rates and slightly lower refinancing activity on average over the period influencing the report. JPMorgan estimates June paydowns to be just over $40 billion. The conventional reports will be out the evening of Friday, July 7, and the morning of July 10 for GNMAs.
Looking ahead to July and August, speeds are forecast to drop about 10% in July on a lower day count and recover in August on a higher day count.
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