Activity over the early first half of the holiday-shortened week was relatively quiet with mixed flows. Data was sparse in the beginning of the week, and many participants were still off on vacation. There was some light Asian buying in the overnight markets as levels had become more attractive on the steady selloff in Treasurys. They were primarily focused on 6% coupons that have dipped below par (99-31 as of midday on May 30). Originator business averaged $1 billion, which is a more normal level, through midweek, at least.
After ASR's Wednesday press time, flows were expected to pick up in the last two days of trading with a significant amount of key data released, including the Employment Report and PCE Deflator on Friday. In addition, Thursday was also the release of the month-end report that was expected to attract index buyers. According to Lehman Brothers, the MBS Index is forecast to extend 0.07-years on June 1. The Treasury Index was expected to lengthen 0.22-years as a result of the quarterly refunding that took place in May.
Last month, the 10-year Treasury yield backed up 25 basis points to 4.884% as of May 29, bringing yields to their highest level since late January. With the contribution of the steady sell-off, mortgages look to close out May with negative excess returns. Month-to-date through May 29, Lehman's MBS Index stood at negative eight basis points, which brings year-to-date performance to negative five basis points. MBS are currently the worst performing sector in May versus ABS (negative one basis point), CMBS (positive three basis points) and corporates (positive19 basis points). On a year-to-date basis, MBS remain ahead of ABS (negative nine basis points) and CMBS (negative 29 basis points), which all lag corporates (positive 36 basis points).
Mortgage outlook
After a busy week of key data capped off with the Employment Report, the PCE Deflator and ISM Index last Friday, economic news this week will die down. On Monday, factory orders are released; Tuesday has ISM Non-Manufacturing Index; revised Q1 Productivity & Costs comes out on Wednesday; Wholesale Trade and Consumer Credit are reported on Thursday; and Friday sees the Trade Deficit. In terms of Federal Reserve officials making appearances, Federal Reserve Bank of Richmond President Jeffrey Lacker will be talking about the economy on Wednesday.
In mortgages, conventional prepayment reports are released Wednesday, with the GNMAs report out on Thursday. The Midwest Cutoff on Class A (30-year conventionals) is also on Thursday, with 48-hour notification beginning Friday. Both tend to be supportive events for mortgage performance.
Current levels are seen as more attractive for many investor types. Lehman Brothers analysts last week said they were feeling more favorably disposed toward MBS. They believe OAS levels are where "it makes sense to go long." They also expect the Federal Reserve will remain on hold, a factor that is making carry look more attractive. On the supply front, Lehman analysts project monthly issuance will start to slow once the impact of slower home price appreciation takes hold.
Increased selling risks are seen as the 10-year Treasury moves above 4.90% and approaches 5% on duration shedding.
Application activity falls
As expected, given the 16 basis point jump in 30-year fixed mortgage rates to 6.37%, the highest level since last fall, application activity dropped 7.3% overall for the week ending May 25. According to the Mortgage Bankers Association, the Refinance Index dropped 13% to 1874.6. This is the first time in 12 weeks that the Refinance Index has dropped below 2000. A year ago, the index stood at 1409 with mortgage rates in the low 6.60% area. The Purchase Index slipped 2.5% to 427. At this time last year, the Purchase Index was at 396.
As a percent of total application activity, refinancing share was 39.7%, down from 42.3% in the previous report. ARM share also was lower at 17.7% from 18.1%. ARM share remains at its lowest level since July 2003.
Prepayment outlook
Prepayment speeds in May are predicted to increase about 8% to 10% from April's level. Contributing to the increase is a two-day rise in the number of collection days and improving seasonals. Currently, prepay speeds are expected to remain almost the same in June and July. Day count in both months is 21 days, which essentially offsets the further slight gains in seasonals. The May prepayment reports are out on Wednesday.
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