Mortgages were on hold until late last Tuesday afternoon as the market waited for Fed Chairman Alan Greenspan's semiannual report to Congress. The Treasury market rapidly sold off following his comments suggesting that the FOMC was still on track to raise interest rates despite some recent weak economic data. Mortgage buyers, meanwhile, breathed a sigh of relief as convexity risk fell, and immediately jumped in to take advantage of the recent cheapening. Buyers included money managers covering underweights - as the market convexity improved - as well as insurance companies, banks, hedge funds and others.

Initially, higher coupons were targeted as a result of carry. However, 6s also benefited from news about the creation of two Fannie Mae Mega pools that pulled $17 billion off the Street about a month ago. As lower coupons lagged, investors began moving down in coupon, too. One trader reported that on Wednesday afternoon, nearly $1 billion moved down in coupon from 6s to 5s. Servicers were also active in 5s and 5.5s. Activity slowed down on Thursday as investors took a breather following the mid-week activity. Given the recent gains, there is the prospect of some profit taking; however, with limited supply, backups in the basis will be shallow, another trader said. In addition, if the selling is accompanied by higher yields, real money buyers will be there to take advantage of the opportunity.

Also helping mortgage performance was the drop in volatility as rates backed up. In recent comments from Lehman Brothers, analysts noted that "any further gains in rates is expected to be accompanied by a decline in vol which should give passthroughs room to richen on a nominal basis."

Over the week, spreads on 30-year Fannie Mae 5s through 6s were three basis points tighter, while 6.5s were in five basis points. In 15s, spreads were two to three basis points better in 4s through 5.5s.

Mortgage application activity slips

The Mortgage Bankers Association (MBA) reported a slight decline in mortgage application activity on a seasonally adjusted basis for the week ending July 16, despite the fact that rates held lower. On a seasonally adjusted basis, the Purchase Index fell 6% to 440, while the Refi Index was down less than 1% to 1651 versus 1662 previously. On an unadjusted basis, the Purchase Index gained 18% while the Refi Index jumped 24%. As a percentage of total mortgage application activity, refinancings were 37.1% versus 35.8% in the previous report. ARM share was little changed at 31.3% versus 31.5%.

Although it's anti-climatic now that rates have backed up, Freddie Mac reported that the 30-year fixed-rate mortgage rate dipped below 6% for the first time since April 22. For the week ending July 23, the 30-year rate reported in at 5.98% versus 6.00% last week. The 15-year fixed rate declined one basis point to 5.39%, while the one-year ARM rate rose 10 basis points to 4.12%.

Looking to this week's mortgage application activity report, JPMorgan Securities analysts expect the Refinancing Index to increase about 5% to the 1700 area. The report is expected to reflect the July 16 rally.

Increased speeds in August and September reports Given the pickup in refinancings over the past several weeks, prepayments are now expected to hold flat to higher in the August and September reports, after declining in July. Current expectations are for speeds to decline around 20% in July and to hold relatively flat in August. September speeds are predicted to be higher with the strongest gains in 5.5s and 6s. Consensus projections show Fannie Mae 2003 5.5s prepaying at 14% CPR in July, increasing to 15% CPR in August, and at 17% by September. This compares to 18% CPR in June. Also, 2003 6s are expected to prepay at 24% and 25% CPR, respectively, in July and August and at 29% CPR in September. The vintage prepaid at 29% CPR in June.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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