Stagnant spreads in the market over the past week have kept mortgages attractive, but an unexciting atmosphere is expected to linger around for at least the next few weeks, market observers say.
"The market's kind of held in there this week," said Gary Singleterry, president of Singleterry & Co., a New Jersey-based mortgage-backed securities hedge fund company. "It hasn't actually moved around a lot. Mortgage spreads have basically been unchanged during the entire week."
"So far on the week, we are about a basis point wider as spread," added Greg Rosenberg, a mortgage researcher at J.P. Morgan & Co. "And swaps are about two basis points tighter."
Swap spreads and corporate bonds have remained wider than Treasurys as well, which is making mortgages relatively attractive. "So relative to Treasurys, we're still fairly wide, once you get back before all the crises of '98 and '99," said Singleterry. "The problem is corporate bonds are also fairly wide when you compare it to what they were before '98," adding that all spreads will need to tighten up slightly.
As for swaps, "It's tough for mortgages and corporates to tighten much relative to swap spreads going forward," he added. "So I think spreads, while the Fed is in its tightening phase, it's unlikely that swap spreads will come in much."
"At the end of last week, mortgages were at their richest level relative to swaps since just after the Fed did their Y2K liquidity provision thing right after Labor Day," added Rosenberg, "and it's not really all that surprising that we've underperformed this week."
Singleterry said that a flattening of the yield curve has reduced the amount of collateralized-mortgage-obligations. "So collateralized mortgage obligation derivatives are probably going to tighten, which they need to because they're still fairly wide. They haven't tightened as much as collateral has tightened over the last few months, so they're due for a little more tightening, but not a lot."
TBAs Looking Good
"After 1999, where over $600 billion in passthroughs were produced, there is a very substantial pool of TBA discounts," said David Montano, director of MBS research at Credit Suisse First Boston. "We, therefore, expect discount rolls to languish in the near future.
"One thing that I can say for sure is there's been a general swing at least in the TBA contracts," said Rosenberg. He added that a preference developed for current coupon 8s and 8.5s, and they have outperformed a little. "They're financing better in the dollar roll market. Especially in the case of 8.5s."
"Rolls should remain strong for 30-year 8s and 8.5s, driven by CMO activity and low front month supply," added Montano. "We also anticipate a strengthening in the dwarf 7s and 7.5s rolls for February and March."
Furthermore, Montano said that dwarfs have seen some strong performance, and "brought the 15-year current coupon back to rich levels versus 30s. We see the basis as being about 3-4 basis points rich for the current level of volatility and the slope of the curve. However, technicals will continue to favor 15s-lower supply. The real value is away from TBA. The lowest pay-ups for discount paper can be found for dwarf 6s and 6.5s. Currently, 25 to 30 WALA dwarf 6.5s are at a 4.5 tick pay-up to TBA, a 13 basis-point pick-up in OAS."
