Lehman Brothers analysts in a recent report said although overseas demand has been robust, it is not enough to absorb any potential shortfall in GSE or bank MBS demand.
Lehman added that with the yield curve expected to flatten or even invert this year, the demand for mortgages from private institutions should wane, though this should be somewhat offset by increased demand from central banks as they continue to ramp up the proportion of their dollar MBS assets.
Lehman researchers said insufficient foreign demand - combined with domestic banks and agencies being sidelined in the market because of the flat curve and tight spreads - produced a period of what analysts estimate to be weak demand technicals.
Analysts estimate foreign demand by combining Federal Reserve and Treasury Department data. The Fed flow of funds account provides the net holdings of agency securities by overseas investors on a quarterly basis. The Treasury Department releases a report on the purchases of U.S. securities by foreign investors on a monthly basis and provides an estimate of net purchases of agency securities by foreign accounts.
According to Lehman, while overseas mortgage holdings increased by about $85 billion in 2005, this was dwarfed by the growth in total mortgage debt, which rose by approximately $800 billion with agency mortgages increasing by about $110 billion.
In a related report, JPMorgan Securities said December data for overseas purchases showed net year-end activity in agency debentures and MBS totaled $9.8 billion. However, new issue volumes showing that only $1 billion of these purchases were actually in MBS effectively counteracted the increase's impact.
"This is a very low number and leaves net [nongovernment] overseas demand down 10% from the peak in 2004," JPMorgan analysts wrote.
They reiterated that central bank MBS purchases somewhat offset this decrease by rising to a net of about $20 billion last year, the highest amount recorded.
Regarding demand from the GSEs, JPMorgan noted that Fannie Mae and Freddie Mac announced a change in their business practices in terms of having a more "total return" focus, rather than merely holding to maturity.
"In other words, they have claimed a willingness to more actively manage the retained portfolio by both buying at the wides and selling at the tights," wrote JPMorgan analysts, who added that there has been 10 basis points of tightening since November as well as a price increase on the securities.
It would be interesting to see if the GSEs use this opportunity to take gains.
"This may be a test case for the new active' management strategy," JPMorgan analysts stated.
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