Flows were modest last week in mixed flows. Ahead of the Federal Open Market Committee statement last Wednesday, mortgages saw better selling, particularly on Tuesday, as the market slipped through 4.75% on the 10-year Treasury due to the PPI-inspired rally and flight-to-quality bid from a military coup in Thailand.
Participation was widespread with buying and selling reported from money managers, banks, servicers and other fast money, although Asian investors stayed by the sidelines hoping for cheaper prices. Following the uneventful FOMC statement on Wednesday and continuing into Thursday's morning session, mortgages were benefiting from the drop in volatility, tightening in swap spreads, as well as a pickup in buying. With the outlook for the market to hold in a narrow range for the near term, investors appear to be putting some of their money to work in mortgages. This includes Asian buysiders, who faced limited attractive alternatives.
The much weaker than expected Philly Fed Survey released at noon on Thursday, however, threw a wrench into the post-FOMC trading and sentiment. Fears were picking up on increasing prepayment risk in 6.5% coupons and potential for increased bank selling. Shortly after the release, the market rallied with the 10-year Treasury yield falling to 4.65% from 4.70% prior to the release and from the previous day's close of 4.73%.
Flows continued to be mostly up in coupon. The 6.5% coupon, in particular, was benefiting as well from the creation of a $4.5 billion FNMA mega pool, which has helped to strengthen the roll some. Originator selling bounced around. However, on average it held to about the $1 billion per day area. Supply was focused in 6% coupons.
Mortgages experienced some limited performance recovery over the week. Month-to-date through Wednesday, Sept. 20, the MBS Index was up seven basis points versus Treasurys, according to Lehman Brothers. This is improved from the three basis points over Treasurys as of Friday, Sept. 15, but still down from the gains made in the first week when the MBS Index was up 15 basis points. Still, year-to-date, mortgages are up an impressive 76 basis points.
Analysts' sentiment remains neutral to positive on the mortgage basis. Those tending towards neutral are concerned about the potential for bank selling if the market continues to rally, as well as, originator/servicer selling in a backup. On the other hand, fundamentals are seen as attractive and volatility remains low.
Leaning towards the positive end, Bear Stearns analysts believe spreads are likely to continue to tighten on the favorable market conditions over the next month or so, further tightening in swap spreads (though they caution that this could be delayed by the special repo in five- and 10-year Treasurys), and lower volatility.
UBS analysts remain modestly overweight on mortgages with an up in coupon preference. They note that, historically, mortgages tend to outperform Treasurys from late September to February. In particular, they calculate that from late September to year-end, the outperformance is about 1/4 of a point.
Refinance Index up in latest survey
The Mortgage Bankers Association reported last Wednesday a 9.5% jump in the Refinance Index to 1748.7 for the week ending Sept. 15. While there was an expectation that activity would increase with the holiday and vacations past, the increase was more than expected. The Refinance Index has not been over 1700 since the week ending Feb. 2 this year when it was at 1751. Meanwhile, after increasing for the previous two reports, the Purchase Index slid 3% to 397.9.
As a percentage of total application activity, refinancings were 43.7% versus 40.3% in the previous report. ARM share was also higher at 27.0% versus 25.5%. Based on dollar volume, refinancings were 47.2% - which is the highest since February 2005 - compared to 45.0% previously. ARM share was steady at 40.5% versus 40.3%.
Mortgages slip lower in latest FHMLC survey
Further strengthening in the market last week allowed mortgage rates to slide lower. According to the latest Freddie Mac primary mortgage market survey, the 30-year fixed mortgage rate declined three basis points to 6.40%. This continues to be the lowest rates have been since the first week of April. Furthermore, rates are down 40 basis points from July's high of 6.80%.
In the other borrowing programs, 15-year fixed mortgage rates averaged 6.06% versus 6.11% last week. One-year ARM rates also saw a noticeable decline of six basis points to 5.54%. Finally, 5/1 hybrid ARMs slipped two basis points to 6.08%.
The further decline in mortgage rates should continue to support refinancing activity.
In remarking on the latest decline, Freddie Mac Chief Economist Frank Nothaft said "A slowing housing market and signs that inflation is leveling off have helped to lower mortgage rates lately and keep them more affordable." He added that he expects the economy to expand at a slower pace going forward versus the first half of the year, which should help to keep inflation in check, and thus mortgage rates low.
September speeds are forecast to slow 12% to 13% in 4.5% and 5% coupons, and 10% and less for higher coupons. The primary reason for the slowing is less collection days at 20 versus 23 in August. Slowing seasonals also contribute to the decline in prepayment speeds. Offsetting to a limited extent, particularly for the higher coupons, is the improved mortgage rate environment in August as the market rallied that led to a pickup in refinancing activity.
For August, 30-year fixed mortgage rates averaged 6.52%, compared to 6.76% in July, while the average of 1584 on the MBA's Refinance Index was up nearly 14% over July. In general, 6% coupons and higher will feel the influence of the better refinancing environment in August.
Looking into October and November, speeds are expected to record moderate gains of around 5% to 7%, largely as a result of an increase in the number of collection days to 21. Speeds in November are seen slowing about 8% to10%.
In research from UBS, analysts said that they expect September prepayments to drop 10% to15%. Speeds on seasoned deep discounts - 4.5% and 5% coupons, 2003 and 2002 vintages - could be down more than 15%, with baseline housing turnover dipping and cashout remaining unattractive at current rate levels.
The analysts also said that 6s and 6.5s of 2005 and 2006 vintages would be prepaying slightly faster compared to how they did in August. This will reflect both a ramping up along the seasoning curve as well as the borrowers' refinancing into the recent rally.
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