It was wild ride for the global bond and stock markets last week as participants reacted to fears of economic slowing in various global markets. These fears were exacerbated by comments from former Federal Reserve Chairman Alan Greenspan, some weak economic data in the U.S. as well as ongoing credit concerns related to the subprime mortgage market.
The hoopla largely began Tuesday in China when the Hang Seng dropped nearly 9% following news that the Chinese government would be clamping down on certain activities that have helped to spur growth there, including speculative buying using borrowed money. This ignited fears about the impact that slowing growth in the fastest-growing economy in the world might have on other world markets. This led to sharp drops in equities around the world, including a 416-point drop in the Dow on Tuesday, and a strong flight to quality bid. The 10-year Treasury rallied 29+/32nds that day with the yield dropping 11.6 basis points to 4.515%.
Contributing to slowing economic fears on the week were comments from former Fed Chairman Greenspan on Monday, speaking via satellite to a conference in Hong Kong. "When you get this far away from a recession, invariably forces build up for the next recession, and indeed we are beginning to see that sign, " he said, citing profit margins that are beginning to stabilize serving as an early sign that the economy has entered the later stages of the cycle. Not helping the economic outlook either was a much weaker than expected durable goods report, a downward revision to the fourth quarter GDP, lower-than-expected Chicago PMI, a large drop in new home sales - although median home prices recorded a modest gain - and a stronger-than-expected decline in construction spending. At the same time, though, the ISM Index came in stronger than expected, while personal income and outlays keep the vigilance on inflation.
With the strength in Treasurys, uptick in volatility and widening in swap spreads, mortgages could not keep up. In the end, mortgages closed out the month of February underperforming Treasaurys. Heading into the final three days of trading, Lehman Brothers' MBS Index was up 13 basis points for the month. However, in the final three days of trading, it lost 24 basis points, closing the month at -11 basis points. For the month, the sector underperformed ABS (two basis points over), CMBS (negative eight basis points) and corporates (eight basis points over). Year-to-date, the MBS Index is also at -11 basis points, and is only ahead of CMBS, which is off 26 basis points.
Given the strong rally and steepening in the yield curve, mortgage activity was elevated and two-way during the week. In particular, servicers were active buyers throughout the week, while money managers and hedge funds were mixed. Indexers did show up for month-end on Wednesday. Overseas investors, meanwhile, were moderate participants. Current levels and the strong rally, however, generally led to better selling from that group. Originator selling was above average at about $1.5 billion per day.
Mortgage outlook
This week sees another active economic calendar. On Monday, ISM Non-Manufacturing Index is reported, Tuesday has the revised fourth quarter Productivity & Costs, Factory Orders and the Pending Home Sales Index, Wednesday includes the release of the Beige Book ahead of the Federal Open Market Committee's March 20 meeting, and Friday gets the key employment report, along with the trade deficit and wholesale trade. Other key events that could influence market direction include release of the ADP Employment report on Wednesday and the Monster Employment Index on Thursday that presages the employment report. Also on Thursday, the Treasury announces details of the upcoming 10-year Treasury note auction that is scheduled for March 13.
It's also a busy week in mortgages with February prepayment data out on Wednesday, and 48-hour notification beginning on Friday for Class A securities. Prepayment speeds are seen slowing about 10% in February overall, which is partly a result of lower day count: 19 versus 21. Barclays Capital analysts also attributed the slowing to increasing mortgage rates in January versus December, and further weakening in seasonals.
Traditionally, paydowns and payrolls tend to be supportive for the mortgage market. However, the current global market uncertainty is an overriding factor currently. Analyst sentiment is also more neutral to negative on the flight to quality bid and resulting volatility risks. JPMorgan Securities analysts shifted to tactically negative on the mortgage basis from neutral. This is due to concerns of higher volatility and uncertain Asian investor sponsorship. The analysts added that the recent rally also reduces losses in banks' available for sale portfolios and could provide an opportunity for banks to get out of some of their holdings. Countrywide Securities analysts are currently neutral to negative on spreads, noting that the weakness in the mortgage sector has coincided with growing concerns in subprime and their effect on the housing market. Countrywide analysts said that if the dislocation is contained and the market reverts back to the previously established trading range, this widening would represent a buying opportunity. "However, this is not a time for heroism," they said.
Bear Stearns is also neutral to negative on MBS for now as "higher volatility should continue to hurt nominal mortgage performance."
Mortgage application
activity increases
The Mortgage Bankers Association reported modest gains in mortgage application activity for the week ending Feb. 23, likely helped by the decline in mortgage rates. The results were in line with Countrywide Securities' experience for that week. The Refinance Index was up 1.2% to 1943.5, seasonally adjusted, while the Purchase Index gained 5.2% to 401.3, more than retracing the previous week's decline. The Refinance and Purchase Indexes stood at 1574 and 401, respectively, a year ago with mortgage rates in the mid-6.20s.
As a percent of total applications, refinancing share was lower at 43.2% compared to 44.9% in the previous report. ARM share was essentially unchanged at 21.1% versus 21.2% previously.
In a report last week, Countrywide analysts discussed the causes for the current high level of refinancing activity given the current level of mortgage rates. Some reasons for the faster pace of refinancing applications are: the flat yield curve that has increased activity out of ARMs and into fixed-rate loans; the increased refinanceability of the fixed-rate sector as there is a large amount of fairly generic new fixed-rate loans with rates above 6.5%; and the relatively low level of primary mortgage rates due to the strong performance of the MBS market, they said.
Analysts went on to see whether the higher level of applications could be a result of, at least partially, to aging ARM loans which are getting ready to reset. To do this, they reviewed data for refinancing applications taken out in January and February where the original loan was an ARM. Looking at the data broken out by loan age and product, analysts noted that as just under 75% of original hybrid loans were 5/1s or longer, leading them to conclude that "prime hybrids are not being refinance as they approach their reset date in large enough quantities to impact the refi application index."
30-year mortgage
rate declines
Fixed and adjustable mortgage rates ranged from unchanged to five basis points lower last week, according to Freddie Mac's latest survey. The declines seemed fairly modest given the sharp drop in 10-year Treasury yields in the past week, nearly 20 basis points.
According to Freddie Mac, 30-year fixed mortgage rates averaged 6.18%, down four basis points from the previous week. A year ago, rates were at 6.24%. For the month of February, the 30-year rate was little changed on average from January at 6.25% versus 6.24%.
In other programs, 15-year fixed mortgages were 5.92% compared to 5.97%, five-year hybrid ARMs were three basis points lower at 5.93%, while one-year ARM rates were unchanged at 5.49%.
The further improvement in mortgage rates should provide stimulation for application activity.
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