Mortgage flows in the early part of the week were below average and mixed. The rally in Treasurys last Monday, to even lower yields following the previous Friday's shocking employment report, brought additional convexity buying from servicers. Buying support also came from real money. Last Tuesday's selloff moved the convexity bid to the sidelines and generated better selling as investors again focused on various risks. This included news that Countrywide Financial was seeking another capital infusion. Uncertainty about Federal Reserve action on Sept. 18 added to general nervousness in the market. Further adding to mortgage woes were poor dollar rolls on the high funding costs. As far as overseas investor participation was concerned, it remained lackluster into midweek. Originator selling was also light, with roughly a $1 billion per day average.
Month-to-date, mortgages are outperforming Treasurys and competing sectors. The MBS Index is up 17 basis points through Sept. 11 compared with negative 16 basis points for ABS, negative four basis points for CMBS and negative 51 basis points for corporates, according to Lehman Brothers.
MBS Outlook
This week's highlight is the Federal Open Market Committee's meeting on Tuesday, Sept. 18. Expectations are increasing that the Fed will cut the funds rate by 50 basis points. Mortgage participants are starting to consider the impact of a Fed rate cut on MBS. Alec Crawford, head of agency MBS strategy at RBS Greenwich Capital, said the market would probably be disappointed with only a 25-basis-point cut, which would likely cause some cheapening. A more positive response is anticipated if the Fed cuts 50 basis points. Crawford said a surprising number of investors are still waiting on the sidelines for the Fed to cut rates before they invest.
But higher rate cuts have their risks as well. For example, Countrywide Securities analysts said that an aggressive rate cut could bring out prepayment and convexity fears, as well as increased fixed-rate supply and implied volatility. If the Fed were to hold rates unchanged, mortgages are expected to cheapen significantly.
Economic data this week includes inflation and housing news. PPI is reported on Tuesday and CPI and Housing Starts on Wednesday. Closing out the week are initial claims, Leading Indicators and the Philly Fed Survey on Thursday.
Application Activity Gains
Mortgage application activity rose in the week ending Sept. 7 as the rally on expectations of a Fed rate hike improved mortgage rates. According to the Mortgage Bankers Association, the 30-year fixed contract rate dropped 17 basis points to 6.25%.
This led to a 5.5% jump in overall mortgage applications, with the Purchase Index increasing 5.2% to 448 and the Refinance Index rising 6% to 1876.6. The results were adjusted for the Labor Day holiday. This is the highest activity since early August.
As a percent of total applications, mortgage refinancings were 42.1%, up from 41.4% previously. The ARM share was also higher, at 13.2%, compared with 12.6% in the week of Aug. 31.
Lower August Speeds
Prepayment speeds in August were previously expected to increase less than 5% overall. However, they slowed 3% to 4%. The day count increased by two compared with July, but the reduced refinancings in July offset this.
The decreased number of refinancings was a result of slightly higher mortgage rates, tighter lending standards and flat home price appreciation (HPA), with many areas of the country showing negative HPA recently. For 4.5s through 6.5s, FNMA speeds declined, on average, by roughly 3%. Speeds on FHLMC Gold and GNMA securities were also slower, on average, by 3% in 4.5s through 7s. FNMA 7s showed sharp declines after temporarily spiking up in August. For example, the 2006 vintage slowed 50% and the 2002s 32%. Speeds in July surged due to changes in Fannie Mae's servicer guidelines, which became effective on June 1. The new guidelines allow loans delinquent for four straight months to be removed from their respective pools.
RBS Greenwich analysts said the strong slower suggests that most of the delinquent loans were removed from the pools. As a result, analysts expect to see a strong bid on FNMA 7s. Credit Suisse estimated that paydowns in August were $34.7 billion, down 2.3% from July's $35.6 billion. Net issuance was estimated at $40.4 billion, up from $37.8 billion previously. Broken out, net issuance of 30-year FNMA/FHLMC Gold was $39.6 billion, while GNMAs were $4.5 billion, said Credit Suisse analysts. The September prepayment reports should reflect a slowing of 15% or so, largely as a result of a drop in day count to 19 days from 23 days. Speeds are seen rebounding in October as day count increases to 22 days. Additionally, there might be some pickup related to the recent rate rally.
Prepayment Outlook
Initial information for September shows prepayment speeds slowing 15% to 20%. The decline comes primarily on a drop in the number of collection days to 19 from 23 in August. At the same time, mortgage rates improved to 6.57% average in August versus 6.70% in July, which stimulated refinancings based on results of the Refinance Index. Speeds are forecast to bounce higher in October as day count increases and is expected to hold steady in November.
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