The U.S. Treasury's announcement last week that it is thinking about restarting regular 30-year bond auctions - which came as a surprise after the Treasury announced earlier this year that it did not plan on reintroducing these bonds - is not expected to have a strong impact on the mortgage market unless intermediate rates increase accordingly and drive up mortgage rates.
"The potential return of the 30-year bond should have a modest impact on relative value of the 30-year MBS coupon stack," said David Goldman, head of Banc of America Securities debt research.
Analysts said that the Treasury's reissuing the 30-year bond would only affect MBS durations to the extent that the curve steepens, most likely affecting only marginal durations. However, the steepening of the curve is only a secondary component, as the dollar prices on the bonds have more of an impact on MBS. The Treasury's announcement and subsequent curve steepening have not caused any major revaluations in the market as of last Thursday, although the up-in-coupon trade benefited from the steeper yield curve.
However, some observers said that the announcement might adversely affect some sectors such as CMOs. Art Frank, head of mortgage research at Nomura Securities, said that the two-to-10-year Treasury steepening is positive for CMO creation. However, a big steepening from 10s to 30s is a negative because dealers have to create 20-year Z-bonds at cheaper levels, thus making it harder to specifically create CMOs backed by 30-year collateral. Frank added last Thursday that since last Monday's close, the 10-year Treasury yield is down three basis points and the 30-year yield increased seven basis points. "The curve from 10 years to 30 years is 10 basis points steeper than it was at Monday's close," he said, adding that this hasn't been a plus for mortgages over the week.
Chris Hanlon, director of mortgage-backed and government securities at Hartford Investment Management Co., said that the 30-year Treasury bond announcement is not a big concern, considering that the impact is too far out on the curve that it would not affect CMO creation. Thus the announcement is still "neutral overall" for mortgages. He added that Z bonds and last cash flow structures have cheapened from where they were previously and currently present buying opportunities. Meanwhile, Hanlon says they "remain pretty close to home" in their strategy given MBS market volatility. Hanlon said that they are still partial to 30-years versus 15-years at this point because the sector still offers good carry and expectations are for two- to 10-year Treasurys to flatten eventually.
Victoria Averbukh, senior CMO strategist at Deustche Bank Securities, said potential steepening from 10- to 30-year Treasurys is likely a non-event in CMO creation. "While a steeper curve usually leads to wider nominal spreads, 10s to 30s year steepness will affect last- cash- flow tranches," Averbukh said. "The CMO market is much more focused on the front cash flows and there is so much going on in the short-end that worrying about potential spread widening in the long end is unwarrened at this point." She also added that potential 10- to 30-year steepening is probably being overstated at this time and it is not clear how much of the spread widening will really be sustained. The CMO pricing, including long cash flows, can be influenced at least as much by prepayment speeds, collateral pricing, and the supply/demand dynamics.
Meanwhile, Bear Stearns analysts speculated on the reasons behind the Treasury's move. Analysts said this might reflect the yield curve's relative flatness, as well as other countries' - namely U.K, France, Spain and the Netherlands - long-term debt issuance. Analysts added that it does not seem spurred by the U.S. deficit as higher-than-expected April tax receipts are lowering this year's deficit projections.
An official new auction announcement is expected by the Aug 3 refunding, with semi-annual $10 billion to $15 billion issues anticipated in early February.
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