Mortgages started feeling heavy last week as the market made further gains. After peaking at 4.892% on Jan. 29, the 10-year Treasury note had rallied 14.7 basis points to 4.745% through Feb. 7. Treasurys benefited from several sources, including a decent Treasury refunding, hedge unwinds of corporate pricings, and an outlook for strength with nearly $47 billion in CMBS conduits showing in the pipeline for February.
After strong MBS selling through most of January as the market backed up on better-than-expected economic data, strong buying emerged as the market found resistance at 4.90%. However, as the market continued to gain strength last week and Asian investors remained essentially sidelined, profit-taking picked up.
Mortgage performance also was negatively impacted by an uptick in volatility and widening in swap spreads. High dealer inventories were also weighing with the better selling. As of the close of Jan. 24, net outright MBS positions at primary dealers were $54.8 billion.
Still, year-to-date through Feb. 7, the Lehman Brothers MBS Index was up 21 basis points compared with nine basis points over for ABS, 19 basis points over for CMBS and 15 basis points over for corporates. Year-to-date, the MBS Index was ahead of ABS and CMBS, but lagged corporates, which have provided 42 basis points in excess return versus Treasurys.
Flows last week were about average and mostly concentrated in the belly of the coupon stack as investors moved up in coupon. Midweek saw increased selling from money managers out of discounts into primarily 6.5s, and, to a limited extent, 6s. The 15-year sector saw buying support around midweek and was outperforming 30s as the product benefited, to some extent, from the rally, a bit of curve steepening and an uptick in volatility, according to an intermediate trader.
There was active profit-taking from hedge funds, while Asian investors remained very limited participants in the market. Talk is that their bogey is now about 10 basis points back of current levels on the 10-year. The near-term window for Asian interest is just this week, as that region of the world will essentially be shutting down for the remainder of the month for celebrations to usher in the Year of the Pig.
Originator selling last week was slightly below its normal $1 billion per day average and down from the previous week's $1.5 billion per day average. Supply remains focused in 5.5% and 6.0% coupons.
MBS outlook from the Street
Analysts' outlook remained mostly favorable toward the MBS sector last week. For example, Credit Suisse enumerated factors favoring the mortgage sector, including the reduced extension risk, a core bearish view on volatility, and a GSE backstop.
UBS analysts were holding with their overweight recommendation since the sector is considered to be in a "mortgage-friendly environment" with the Federal Reserve -on-hold and some foreign and domestic real money interest.
Bear Stearns analysts expect swap spreads to tighten in February as a result of pending heavy CMBS issuance. In addition, they anticipate ongoing decent demand from money managers, servicers, and overseas investors, at the same time that TBA supply is being trimmed by the issuance of 10/20 pools.
After a week of limited data, it picks up this week with a fairly decent calendar. In particular, Tuesday gets international trade; retail sales and business inventories are released on Wednesday; Thursday's session has the Empire State Manufacturing Survey, Import Prices, Industrial Production/Capacity Utilization and the Philadelphia Fed Survey, and on Friday, housing starts and PPI will be released. The markets also will be focused on Federal Reserve Chairman Ben Bernanke's semiannual report to Congress before the Senate Banking Committee on Wednesday, which will be repeated on Thursday before the House Financial Services Committee. The week includes an early close at 2:00 pm Eastern Standard Time on Friday, ahead of Monday's full close for President's Day.
In the mortgage sector, 48-hour notification begins on Tuesday for Class B securities (15-year MBS) and on Thursday for Class C (30-year GNMAs).
activity holds steady
The Mortgage Bankers Association reported little change in application activity for the week ending Feb. 2 despite a nine basis point increase in 30-year fixed mortgage rates that week to 6.34%. The Purchase Index slipped less than 1% to 405 from 408, and the Refinance Index was essentially unchanged at 1943 rising from 1940. A year ago, both indices stood at 425 and 1751, respectively.
As a percentage of total applications, refinancing share was up slightly to 47.1% compared with 46.1% previously. ARM share also increased to 22.3 from 21.4.
Mortgage rates decline
in latest survey
Mortgage rates slipped last week as interest rates came off recent highs due to strong economic data, in part on the weaker-than-expected employment report last Friday. In its primary mortgage market survey, Freddie Mac reported that 30-year fixed mortgage rates averaged 6.28%, retracing two-thirds of the previous week's rise. The current level is up slightly from a year ago when it was 6.24%. Meanwhile, 15-year fixed mortgages fell four basis points to 6.02%. On the adjustable side, rates were down five basis points to 5.99% and 5.49%, respectively, for five-year hybrid and one-year ARMs.
Mortgage application gains have slowed recently with the increase in mortgage rates. Last week's easing in rates should keep activity near current levels.
Freddie Mac Chief Economist Frank Nothaft expects 30-year mortgage rates to average between 6.3% and 6.5% this year. He also anticipates that with the flat-to-higher rate environment, the share of refinancings should gradually contract. The dollar volume of home equity cashed out should also drop. Nothaft currently projects cash-out activity at $230 billion in 2007, dipping from $314 billion in 2006.
Looking ahead, early indications show FNMA speeds slowing about 5% in February overall, partly as a result of lower day count: 19 versus 21. Partially offsetting this factor is an improvement in seasonals in February compared with January.
In March, speeds are expected to surge 20% on a three-day increase in the number of collection days as well as strengthening seasonals. Finally, April's lower day count suggests speeds will slow about 5% from March's currently predicted levels.
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