Mortgages put in a good performance last week aided by better technicals, low volatility and generally tighter swap spreads. According to Lehman Brothers, the MBS Index is up 25 basis points month-to-date. This brings the year-to-date performance to 85 basis points over Treasurys, back to its highest level of the year reached at the end of February.
There was widespread buying participation from money managers, servicers, Asian investors and others - directed mostly down in coupon - with the 10-year yield holding close to the 4.80% level on mixed economic data. Specifically, the inflation reports, housing starts and the National Association of Home Builder's Housing Market Index (HMI) numbers support the continuation of the Federal Reserve pause for the foreseeable future. Furthermore, the Federal Reserve's focus will remain inflation based on the annualized CPI number. Meanwhile, originator selling - which had averaged nearly $2 billion per day last week - fell back to its normal area of $1 billion a day and less. Flows, however, were down from the previous week given the narrow range in which the market was trading and on the tightening in spreads. Asian investors were quieting down in the latter half of the week. Better participation is expected from that group if the market backs up modestly from current levels. However, the outlook for overseas buying is favorable with the record sized trade deficit as well as data from the TIC flows report that has shown good buying from foreign accounts.
Of particular note was activity in FNMA 5s and 6.5s last week. There was a strong bid showing up midweek for FNMA 5s. According to JPMorgan Securities strategic principal trader David Montano, it appeared to be coming from the Street as dealers may have oversold the coupon. The 6.5 coupon also saw interest Tuesday following news from Fannie Mae of $8.8 billion in mega creation in 6.5s for October. There didn't appear to be follow-through interest, however, after Tuesday. In a report, JPMorgan analysts said there is sizeable float in the coupon.
The overall outlook for the mortgage market is favorable based on continued low volatility, a stable Federal Reserve, overseas and bank support and potential for corporate crossover buying. Concerns continue to be the slowing in the housing market and its impact on prepayment speeds, high dealer inventories and FAS 155. With the recent tightening in spreads and strong performance, however, some analysts are downgrading their recommendations. For example, UBS analysts have moved from a heavy overweight to a modest overweight following recent tightening. They expect mortgages will continue to outperform, but said most of the really easy money following its underperformance in late August through September has been made back. JPMorgan analysts also turned tactically negative on the mortgage basis midweek. They said that while sponsorship, supply and volatility seem fine, spreads are a bit on the tight side. They would move back to neutral with a several basis point widening in spreads.
Bank of America to sell $100 billion from portfolio
In news out Thursday morning, Bank of America said it would "permanently reduce" its securities holdings by at least $100 billion over the next couple of years. The MBS market reaction was swift to the news, widening out several basis points before moving back in. At midday, 30-year mortgage spreads were 1.50 to 1.75 basis points wider versus little changed in early trading. At press time, there was no information about what will be sold, or how much in MBS.
Mortgage application activity falls 2.2%
Mortgage application activity was slightly lower for the week ending Oct. 13, according to the Mortgage Bankers Association as mortgage rates moved higher. The Refinance Index fell 5.3% to 1758.2 from 1857. After peaking two weeks ago, the Index has steadily declined. However, the level is the highest since January of this year. Meanwhile, the Purchase Index moved slightly higher to 384.7 from 383.3 previously.
According to Freddie Mac, mortgage rates held little changed this week from last week. The 30-year fixed mortgage rate slipped one basis point to 6.36%. So far in October, the 30-year has averaged 6.34%, down six basis points from September's average. One year ago, the rate stood at 6.10%.
In the 15-year program, mortgage rates held unchanged at 6.06%. On the adjustable side, both 5/1 hybrids and one-year ARM rates rose one basis to 6.11% and 5.57%, respectively.
"Mortgage rates didn't move much either way this week as the markets wait for the next scheduled [Federal Open Market Committee] meeting," said Freddie Mac Chief Economist Frank Nothaft. "General consensus leans heavily toward the notion that the Fed will not raise rates at the meeting, taking upward pressure off mortgage rates this week." He added that a rate change in either direction would have an impact on short-term rates more directly, but what the Federal Reserve would say in its statement can have an effect on long-term rates.
With rates holding steady, refinancing activity is expected to have held steady to slightly lower, according to JPMorgan analysts, for the week ending Oct. 20.
Prepayment outlook
Speeds in October are expected to increase around 10% to 12%, aided by an extra collection day and increased refinancing activity as a result of a more favorable mortgage rate environment in September.
Looking to November, speeds are currently projected to be flat to down slightly from October as a result of a lower day count and weaker seasonals. Larger percentage declines are projected for December for similar reasons.
In a recent report, analysts from Barclays Capital said that the refinance-response curve in the October prepayment report was less aggressive than usual. Thus they expect that higher rates combined with a weakening housing market would keep refinance aggressiveness in check over the coming months. They added that for the November prepayment report, a day-count increase of one along with a 12 basis point drop in driving rates, should cause a 1 CPR increase on 5s, a 1.5 CPR pickup on5.5s, and a 2 to 3 CPR acceleration on 6s through 6.5s.
For the December report, Barclays analysts said that weaker seasonals and a day-count drop of one should drive down conventional speeds by one to two CPR.
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