The directionality of mortgages was very apparent last week with the market moving up and down in response to perceptions about future Federal Reserve action and the economic data. Monday experienced better selling from real and fast money as the market traded lower, but this was reversed on Tuesday with strong buying from overseas, money managers, and servicers as the market rallied strongly with the 10-year Treasury yield falling to 4.70% from Monday's 4.77% close. Profit-taking from money managers showed up on Wednesday as the market traded lower, leading mortgages to underperform. In early trading Thursday, the 10-year yield had rallied six basis points - in part on favorable economic news and a flight to quality bid related to the bombing in Iraq- and mortgages were strongly outperforming.
Flows were concentrated in 5s through 6s and influenced by shifts in the curve shape, though FNMA 5.5s caught strong interest early in the week on expectations of large mega pool creation that was also causing the roll to heat up. The report was issued Wednesday afternoon showing the creation of two pools: 745412 for $1 billion and 745418 for $12 billion. The roll was trading at 3.625 before the report but had declined to 3.25 Thursday morning. It is not expected to trade below 3, according to one trader.
Mortgages have struggled in March. According to Lehman Brothers, the MBS Index has returned negative 35 basis points versus Treasurys so far in March, reducing year-to-date performance to 50 basis points over Treasurys. At the end of February, year-to-date performance was 85 basis points over Treasurys.
Analyst sentiment favors a neutral to slightly negative bias. Positives include still generally favorable technicals - although dealer net inventories are higher and large bank MBS buying was low, according to the latest weekly data from the Federal Reserve, potentially lower volatility, overseas participation, and corporate crossover buying. On the negative side, valuations are seen as rich, there is risk of duration shedding if rates back up, and quarter one end is fast approaching which traditionally sees selling from banks and a pause from Japanese investing, which is related to their year-end.
Application activity holds fairly steady
Despite the recent jump in mortgage rates, mortgage application activity was surprisingly little changed overall for the week ending March 10. According to the Mortgage Bankers Association, the Refinance Index declined 2% to 1584, while the Purchase Index rose 1% to 403.
Meanwhile, mortgage rates dipped in Freddie Mac's latest survey. The GSE's weekly mortgage rate survey recorded declines in mortgage rates for the week ending March 17, with the largest drops showing up in adjustable loans.
The 30-year fixed rate averaged 6.34%, down three basis points, and rates on 15-year fixed loans slipped two basis points to 5.98%. On the adjustable side, 5/1 hybrid ARM rates dropped 10 basis points to 5.93%, and one-year ARM rates were at 5.37% versus 5.45%.
"Financial markets, hedging against the potential build up in inflation, pushed mortgage rates higher last week," said Freddie Mac Chief Economist Frank Nothaft last Thursday. "However, market indicators this week seemed to point to less of a threat of inflation, and that allowed rates to drift a little lower."
Nothaft also noted that although housing starts fell in February, the numbers were still stronger than what was forecasted, adding that the January figures were revised upward. He saw this as a positive sign that housing activity, although slowing from record levels set in recent years, will remain robust this year.
Based on the limited response of application activity to the 13 basis point increase in 30-year rates in the week ending March 10, as well as the small reversal last week in fixed-rate mortgages suggest a stronger response in the MBA's next report. Analysts from Lehman Brothers predict a decline to the 1500 to1550 area.
Current Street consensus estimates show speeds on FNMA 5.5s and lower increasing around 30% or more in March, with higher coupons prepaying 20% to 25% faster. GNMA speeds are estimated to increase around 15% to20% for most coupons and vintages. The large increase is due primarily to a higher day count -23 in March, versus 19 in February - and improving seasonals.
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