Mortgages are off to a strong start in September. According to Lehman Brothers, the MBS Index has outperformed versus Treasurys by 11 basis points month to date through Sept.6, and brings year-to-date gains to 80 basis points over.
Specifically, mortgages benefited last week from tightening in swap spreads related to a heavy corporate and CMBS calendar expected for September. Other factors supportive for mortgages were continued low volatility, the modest sell-off in Treasurys that moved the 10-year Treasury from 4.73% as of the close of Sept.1 to over 4.80% in early trading on Thursday, and looming paydowns that would be out on Friday. Throughout the week, flows were two-way and mostly up in coupon with widespread domestic participation, particularly from hedge funds and servicers. Asia, meanwhile, remained quiet despite the cheapening in prices. Originator selling also was uneventful last week.
Sentiment in the mortgage market is generally neutral to positive on the sector. For example, UBS analysts continued to hold with their modest overweight recommendation last week. They noted that since mid-August, mortgages have lagged seven to eight ticks, and they believe the basis looks fairly attractive. At the same time, however, they stated the market remains in a directional mode and is likely to underperform on rallies and strengthen on sell-offs.
Meanwhile, JPMorgan Securities analysts said Wednesday that they had turned positive on the mortgage/swap basis, stating that OAS levels on current coupons are nearing their widest levels for the year. They added that hedge-adjusted carry had improved as well. Another positive that was noted was that the backup has increased the unrealized losses in banks' available-for-sale portfolios that may reduce bank selling.
In a cross-sector strategy report from RBS Greenwich Capital, analysts said that despite MBS risks such as a slowing housing market, they "are perhaps less concerned than consensus about the sector." They said that mortgages shouldn't overly suffer if the current interest rate environment is sustained. They added that with the Treasury curve below Fed Funds, investors are left with little risk premium for extending duration and overly dependent on weak economic data. "As a result, demand for spread from other key sources of risk - credit and negative convexity - is unlikely to evaporate despite the less generous pricing," analysts said.
There are underlying concerns for the sector if the market rally returns and strengthens, in part on expectations that this would cause volatility to tick up. At the same time, a sharp sell-off raises fears of extension risk. Also a concern for the sector is the slowing in the housing market. There is some key data looming in the latter part of this week that could move the market, including retail sales on Thursday and CPI on Friday.
In addition to the data potentially impacting activity this week, mortgage flows will also be influenced by settlement activity. Monday begins pool notification for 30-year conventionals, and Thursday, Sept. 14, for 15-year MBS. Roll activity looks to be uneventful as rolls are trading at or below carry.
Refis slip
The Mortgage Bankers Association reported a 2% increase in mortgage application activity for the week ending Sept.1. The gain came on a 3.7% increase in the Purchase Index to 389.7. Despite declining rates, purchase activity had steadily slipped in the previous three reports. A year ago, the Purchase Index stood at 488.
After gaining in the past three weeks, the Refinance Index declined 1% to 1594.7. Activity fell despite a four basis point decline in the 30-year fixed mortgage rate last week. Last year at this time, refinancing activity stood at 2314.
After declining for six straight weeks, mortgage rates moved slightly higher last week in response to the market sell-off. Freddie Mac reported that 30-year fixed mortgage rates rose three basis points to 6.47%, 15-year fixed rates were up two basis points to 6.16%; 5/1 hybrid ARMs rose to 6.14% from 6.11%, and one-year ARM rates averaged 5.63% versus 5.59% last week.
With the slight increase in mortgage rates and the Labor Day holiday, refinancing activity is expected to have declined further in the holiday-shortened week. JPMorgan is predicting this week's print on the Refinance Index to be around 1575.
Freddie Mac's Chief Economist Frank Nothaft said that while he expects mortgage rates to fluctuate as economic data is reported, he believes they will remain in the 6.5% to 7% range for the remainder of the year.
The August prepayment information was released after ASR's deadline last Friday morning. Paydowns are estimated at $40 billion, up from $34 billion in July.
The current consensus outlook shows speeds increasing around 10% with lower coupons expected to show slightly larger percentage gains, and higher coupons slightly lower. The increase in speeds is primarily due to a higher day count - 23 days versus 20 days in July.
Over the period influencing the report, mortgage rates and refinancing activity were little changed from the previous month. For example, 30-year fixed mortgage rates in July averaged 6.76% versus 6.69% in June, according to Freddie Mac's survey, while the Refinance Index averaged 1395 in July, down less than 3% from a 1436 average in the previous month.
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