Some measure of calmness entered into the global equity markets last week, which was good news for the mortgage sector. With global markets stable to higher, volatility declined, and swap spreads tightened.
The week saw active volume in two-way flows. Although by midweek, buyers were said to outnumber sellers by a ratio of either 2 to 1 or 3 to 1. There was opportunistic buying from real and fast money investors following the recent cheapening on the flight to quality in late February, though investors were easily swayed to take profits on periodic strengthening. Servicers were also strong buyers. Investor interest was mostly in the higher coupons, though money managers were mentioned buying in 5%s and 5.5s%s. Overseas investor interest was nothing to write home about as their participation remained limited given the yield levels and market uncertainty. Originator selling stayed above average at over $1.5 billion per day with supply in 5.5%s and 6%s.
Month-to-date through March 7, excess return versus Treasurys improved to negative one basis point on the Lehman Brothers MBS Index from negative14 basis points month-to-date through March 5. Year-to-date, the MBS Index was down 12 basis points.
Mortgage outlook
This week has a full economic calendar that includes inflation numbers. Other reports are the Retail Sales and Business Inventories on Tuesday; the fourth quarter Current Account Deficit and Import Prices on Wednesday; the PPI, Empire State Manufacturing Survey and Philly Fed Survey on Thursday; and the CPI, Industrial Production/Capacity Utilization and the preliminary March reading for Michigan Sentiment on Friday. Economic data has had less of an influence on the market than usual, given the global and subprime market fears. That could be waning some with the equity markets showing more calmness and some recovery last week. If this carries on to this week, there could be some return to normalcy with the bond market responding to the data mentioned above.
Further gains in the market, either from a flight to quality or weak economic data, will continue to add to convexity concerns if the market rallies significantly further. Research from Countrywide Securities noted that convexity pressures were rising, mostly because the higher interest rate environment of the past year and-a half has allowed the mortgage market to gradually rebuild its stockpile of higher-rate loans. Another factor adding to convexity pressures is the current significant size of conforming loans. Larger loans are quicker to refinance when opportunities arise.
Still, the mortgage market is a discount-priced market for now, and Countrywide estimated rates would have to decline by 30 basis points to get the average MBS to trade at par, and by 70 basis points for the price to average 101. Analysts calculated the peak in negative convexity occurs with rates down 50 to 60 basis points, or around 4% on the 10-year Treasury.
The borrower profile in the mortgage universe adds to convexity risks, analysts said. As previously mentioned, the large conforming loan balance increases refinance risks in those loans. Another factor they mentioned that could come into play in an extended rally is that many lower coupons are populated by higher-quality borrowers. So the further the market rallies, the more that large loans to top-quality credits will have refinancing opportunities.
Street analysts last week were more cautious on the sector given the higher volatility risks.
Deutsche Bank analysts were holding neutral on the basis and noted the increased refinance risk that has entered the market and recent bank data from the Federal Deposit Insurance Corp. showing further shrinkage in net interest margins for banks in 4Q06 as negatives for the sector. On the other hand, UBS analysts slightly upgraded their overweight from a six to a seven. They said the flight to quality is overdone and that there are concrete signs of stabilization.
Specifically related to mortgages this week is pool notification on Class B securities (15-year MBS) that begins on Thursday. Last week, 30-year conventionals settled. The only roll that traded well heading into Friday's 48-hour day was the FNMA 7 roll. Talk suggested a "squeeze" as production in the coupon has been very light.
Mortgage application
activity up
As expected, mortgage application activity was up in the week ended March 2 as a result of lower mortgage rates. According to the Mortgage Bankers Association, the Refinance Index surged 15% to 2234 as 30-year fixed mortgage rates declined to 6.18% from 6.30% two week's earlier. This is the highest activity level since the week ending Dec. 8 when it reached 2304. A year ago, the Refinance Index was at 1614 with 30-year rates just slightly higher in the mid-6.20s.
Meanwhile, the Purchase Index was up just 1% to 405.3. This was substantially less than what Countrywide Securities said it experienced during that week: a 10% increase. A year ago, purchase activity was at a similar level - 399.
As a percent of total applications, refinancings were 46.1%, up from 43.2% in the previous report. ARM share was slightly higher at 21.4% compared to 21.1%.
Mortgage rates drift lower
The 30-year fixed mortgage rates declined to 6.14% last week from 6.18% the previous week, Freddie Mac reported. This is the lowest rates have been this year, and the lowest since early/mid December when they ranged between 6.11% and 6.13%. A year ago, 30-year fixed rates were 12 basis points higher at 6.26%.
For the remainder of the year, Freddie Mac economists expect 30-year fixed-rate mortgages to average between 6.30% and 6.40%, as they expect GDP growth to pick up in the first half of this year to 2.6% and average 3% for the year.
Freddie Mac also reported a six basis point decline in 15-year fixed mortgage rates to 5.86%. This is close to last year at this time when it averaged 5.89%. On the adjustable side, five-year hybrid ARMs and one-year ARMs slipped three and two basis points, respectively, to 5.90% and 5.47%.
With the further declines in mortgage rates, application activity was expected to remain firm.
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