The unchanged Federal Open Market Committee stance and the entry of Hurricane Rita into the picture made last week interesting for the MBS market, particularly with long rates rallying strongly and the curve flattening significantly. Ahead of and following the rate hike, mortgages experienced good two-way flows with better buying in the basis. Both real and fast money covered shorts and overseas buyers took advantage of the higher yields.
By midweek, however, mortgages began to feel the effects of the bull flattening. Wednesday saw a rather lackluster session with primarily fast money and servicers in the picture. In early trading Thursday, there was better selling taking place from both real and fast money as well as servicers, pressuring spreads moderately wider. Meanwhile, originator selling returned to its average $1 billion per day level.
Overall, the environment is not seen as too positive for mortgages as the lower yields tend to reduce the overseas and bank support. The flattening curve also reduces the carry advantage (see related story p.16). Other negatives for the sector are unattractive rolls, increasing fixed rate supply and uncertain demand support. JPMorgan Securities analysts report that net fixed rate supply this month would be the highest since the autumn of 2003.
Additionally, growth in the 30-year sector could match the late 2003 pace. Lehman Brothers researchers are concerned over the lack of a strong demand base to support the market in a spread event. Analysts note, for example, the slowing bank deposit growth, stronger C&I loan demand and concerns about proposed GSE regulation that could limit their portfolio size.
On the other hand, some analysts are recommending a slight overweight to the sector, due to its recent cheapening. Countrywide Securities analysts, for instance, noted that the mortgage basis widening in recent weeks has improved the sector's risk/reward profile. With the prospects for curve flattening, lower coupons are likely to benefit, analysts added. UBS held with its modest overweight following the FOMC's statement, adding that mortgages still look very attractive to foreign entities.
Mortgage application activity rises 1.5%
Mortgage application activity was slightly higher for the week ending Sept. 16. The Mortgage Bankers Association reported that the Refinance Index gained 7% to 2354 while the Purchase Index slipped nearly 3% to 500. Activity was in line with expectations.
As a percentage of total application activity, refinancings were 45.6%, up from 42.9% in the previous week. ARM share also rose to 29.8% from 28.2%.
Mortgage rates rose for the second straight week, according to Freddie Mac's weekly survey. Still, the increase was slightly less than expected. Last week, the 30-year fixed mortgage rate increased to 5.80% from 5.74%; the 15-year fixed rate was up five basis points to 5.37%; the 5/1 hybrid ARMs rate also rose five basis points to 5.31%; and the one-year ARM rate averaged 4.48% versus 4.46% previously. Expectations are that application activity will be down modestly in the next report by 4% to 7%.
"Mortgage rates look like they are back on track where the Fed wants them, which is gradually rising," said Freddie Mac Chief Economist Frank Nothaft, adding that the GSE is calling for a slowing housing market going into 2006, due, in part, to the rising rates.
Speeds are expected to slow due to seasonal factors, declining refinancing activity, and a lower day count. Consensus predictions are for September speeds to slow 10% to 15%, followed by a roughly 5% decline in October, and further declines in November.
JPMorgan analysts, for instance, are on the higher range, anticipating a 15% to 17% decrease in September prepayments. They add that the decline could be larger if California pools continue to slow. Though the MBA Refinancing Index levels imply a 7% decrease, this is offset by the two fewer collection days and seasonal turnover that is expected to slow by 10.
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