Last week saw lackluster trading with limited economic data for stimulation, and this week's CPI and PPI reports as well as Chairman Ben Bernanke's semiannual testimony to Congress further limiting participation. There was expectation that the early week events for mortgages - paydowns and calendar flip - would provide a supportive tone through the first half of the week at least, but the looming near-term events and medium-term outlook kept investors close to the sidelines instead.
Overall volume was below average with flows directed out of 5% coupons and into higher coupons. JPMorgan Securities strategic principal trader David Montano said in comments last week that it's a bit puzzling that the continuing cheapening in 5s isn't drawing any support. He said there are likely "fears that there will eventually be outright selling in the coupon and given the magnitude of the position, market caution might be justified." The impact of a slowing housing market is also a concern.
Month-to-date through July 12, Lehman Brothers' MBS Index shows excess return versus Treasurys at negative two basis points. Year-to-date, mortgages are up 29 basis points.
Analysts last week turned more neutral on the sector from slightly positive. Barclays Capital analysts, for example, noted the ongoing uncertainty related to future Federal Reserve action, a sharp slowing in prepayment speeds that would lead to a repricing of the MBS coupon stack and the effect of continued Federal Reserve tightening on mortgages as reasons for their downgrade.
Reasons given by JPMorgan for their move to neutral were similar to Barclays and included an outlook for firmer longer-dated volatility, greater prepayment leverage in the mortgage market and the inverted curve environment. Analysts expect volatility could increase on a shift in the types of mortgage buyers to hedge funds and money managers - who tend to hedge with volatility - from banks and Asia. Regarding prepayment leverage, with most of the market trading at a discount, valuations are becoming more sensitive to turnover assumptions.
Looking back over the period 2004 to present, JPMorgan analysts said that once 100 basis points out of the money, mortgages generally widened around five to seven basis points in OAS per 100 basis point additional sell-off.
Additional concerns are ongoing lack of Asian buying, uncertainty about how supportive large banks will continue to be and the high level of dealer inventories.
Application activity
holds steady
Mortgage application activity rose 1% overall for the holiday-shortened week ending July 7. The Mortgage Bankers Association reported that Refinance Index slipped 1.6% to 1400.5, while the Purchase Index was up 2.6% to 425. Countrywide Securities analysts suggested that if the MBA used a 3.5-day seasonal adjustment, the decline in refinance activity would be fairly small based on their experience for that week.
As a percentage of total loans based on dollar volume, refinancings declined to 36% from 37.6%. ARM share also fell to 41.0% from 43.2%.
Last week, JPMorgan analysts remarked on the continuing high level of the Refinance Index versus historical levels. "The two most plausible arguments are the growth in affordability products (hybrid, hybrid IO, MTA) and a strong housing market (more cash-out activity, greater mobility)," analysts said. They expect the index to remain elevated unless the housing market slows considerably.
Mortgage rates lower for
the first time in five weeks
Mortgage rates were several basis points lower last week, according to Freddie Mac's latest survey. This is a result of the recent employment report rally that moved yields lower. For the week ending July 14, 30-year fixed mortgage rates averaged 6.74%, versus 6.79% the previous week. A year ago, the 30-year rate was at 5.66%. Rates remain at their highest level since the Spring of 2002.
Meanwhile, 15-year fixed mortgages were down seven basis points to 6.37%; 5/1 hybrid rates declined six basis points to 6.33%; and one-year ARM rates reported in at 5.75%, down eight basis points from the previous report.
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