Activity and flows in MBS were influenced primarily by the Federal Open Market Committee (FOMC) meeting this week.
Heading into Wednesday's statement, there was active buying down in coupon into 30-year 3.0% and 3.5% coupons by hedge funds, real money, money managers and overseas in anticipation that the Fed would engage in additional stimulus action that would involve buying MBS.
At the same time, supply was heavy at a daily average of $2.5 billion on Monday and Tuesday on a combination of servicers clearing pipelines ahead of Wednesday's risk and Treasuries selling off. It was more than offset, however, by the private demand and Fed with the buy/sell ratio talked at 3-4:1.
Over the first two trading sessions, Barclays MBS Index outperformed Treasurys by six basis points, while the 30-year current coupon spread tightened from +107/10-year notes as of June 15 to +101 as of Tuesday's close.
The FOMC, however, did not acquiesce to the mortgage market's desire for additional Fed buying beyond reinvestment of agency MBS and debenture paydowns. Instead, the Committee announced an extension of Operation Twist through the end of the year using Treasurys only.
There was some consolation in that QE3 was not off the table as the statement read: "The Committee is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability."
Chairman Ben Bernanke also stated at the afternoon press conference that "additional asset purchases are among the things we would consider if we need to take additional measures to strengthen the economy." He added the Committee was prepared to do more but wanted further information on the state of the economy as well as euro zone.
Not surprisingly, production coupons sold off sharply on a pickup in selling with investors moving up in coupon, while originator supply hit $3 billion for the day. Investors, however, returned to lower coupons by late morning on Thursday following weaker-than-expected economic news, reports that Moody's Investors Service would be announcing ratings downgrades to banks (which they did after the close), and soaring borrowing costs for Spain and other eurozone countries as this reinforced expectations of future Fed action.
Higher coupons experienced better support on the knee-jerk sell-off in production coupons with the UIC trade outperforming on both Wednesday and Thursday. These coupons had been pressured since the release of the May prepayment reports in early June that showed stronger than expected HARP speeds and servicer participation.
Providing confidence to move higher was the drop in Home Affordable Refinance Program (HARP) refinance applications for the week ending June 15.
"Refinance volume increased again last week, but the composition of activity changed markedly," said Michael Fratantoni, Mortgage Bankers Association vice president of research and economics. Despite rates remaining near all-time lows, conventional refinance application volume declined, and the HARP share of refinance activity dropped to 20% [from 28% in recent weeks].
“On the other hand, Federal Housing Administration (FHA) refinance volume exploded to an all-time high, more than doubling over the week. New, lower FHA premiums on streamlined refinance loans came fully into effect, and borrowers seized the opportunity to lower their mortgage rates without increasing their FHA premiums.” Indeed, the MBA's Government Refi Index surged 121% to 8872 in the week ending June 15 following a 28% jump in the prior week as the FHA premium change became effective June 11.
While the market expected an increase in government refinance applications, the surge was stunning. Credit Suisse MBS analysts suggested the spike could partly be the result of lenders canceling/resubmitting in-process applications that qualified for the MIP reduction, but "this week's increase remains extraordinary even after this adjustment, suggesting an extreme front loading of pent-up applications from qualifying FHA borrowers." They anticipate activity to reverse in the weeks ahead, in part, as several large lenders have restricted their streamlined refis to existing customers.
GNMAs had been under increased selling pressure from overseas and various domestic accounts since the second week of June and it was further exacerbated this week. Since around June 11, GN/FN 3.5, 4, 4.5 and 5.0 swaps have lost an average of 20 ticks.
Selling from mortgage bankers averaged $2.5 billion per day for the week compared to $1.9 billion previously. Meanwhile, Fed buying held to a daily average of $1.2 billion indicating supply coverage of less than 50%.
Volume was stimulated by the FOMC meeting with Tradeweb averaging 105% through Thursday compared to 88% last week. Excess return to Treasurys on Barclays MBS Index over the past five days was +1 basis point with month to date at +16. The 30-year current coupon yield declined to 2.64% from 2.66% as of last Friday with the spread to Treasurys five basis points tighter to +102.