Mortgages are off to an okay start in April after a disastrous March. The MBS Index has returned plus seven basis points in excess return versus Treasurys in the first three trading days of April, according to Lehman Brothers.
Flows last week were modest, but mostly supportive in anticipation of late week positives. One was the reinvestment of March paydowns, which is estimated at over $40 billion. The second factor was the expectation of a downtick in volatility following the employment report.
The intermediate sector saw increased buying interest from both real and fast money investors last week. They were buoyed up by the curve steepening and first quarter underperformance versus 30s. The 30-year 6.5 coupon also saw good demand last week; particularly noted was a sizeable investment in that coupon from a servicer. This has contributed to strengthening in the roll.
Overseas investors have made only a limited appearance so far in April. Some Street analysts believe this will pick up following last Friday's payroll news. Whether overseas buying will be enough, however, is a big question. In their midweek comments, JPMorgan Securities analysts were modestly underweight mortgages. Besides fundamentals being unattractive, they don't believe overseas buying will be sufficient enough to significantly tighten spreads from current levels.
Mortgages are back to a directional mode - lagging on sell-offs and strengthening on rallies. Sentiment is mostly neutral to slightly negative. Technicals continue to be supportive with originator selling holding to $1 billion per day or less on average. Concerns include rich valuations, and vulnerability from delta-hedging if the market sells off from current levels, say JPMorgan researchers. Their preference continues to be up in coupon.
Events influencing activity this week include settlement and a short trading week. 48-hour notification begins on Monday for 30-year conventional MBS, and on Thursday for 15-year MBS. A short trading session is expected this week with a full close on Friday for Good Friday with an early 2:00 EDT close on Thursday.
MBS return potential
when Fed concludes
In research last week from Barclays Capital, analysts reviewed the potential impact of the end of the Federal Reserve tightening cycle on MBS. They looked at previous periods and noted that in the past, "MBS returns tend to improve sharply toward the end of a Fed tightening cycle." The main reason for this is the duration component. In the last two cycles, being long duration paid off, they found.
Analysts also said that returns on a duration-hedged basis also tended to improve towards the end of a cycle. The reasons for this may be the reduced uncertainty with the Fed action concluded, and investors feeling more confident about investing.
activity up 7%
For the week ending March 31, mortgage application activity was higher despite the increase in mortgage rates. Application activity was stronger as borrowers reacted to the prospect of even higher rates down the road. The Mortgage Bankers Association reported that the Refinance Index gained 5% to 1640, and the Purchase Index rose 8% to 438.
As a percentage of total application activity, refinancings were 36.6%, down from 37.3% in the previous report. The ARM share was little changed at 28.5% versus 28.8%.
30-year fixed mortgage
rate hits 6.43%
The 30-year fixed rate mortgage rate rose to 6.43% from 6.35% for the week ending April 7, according to Freddie Mac's latest primary mortgage market survey. This is the highest the rate has been since it reached 6.44% in early September 2003. With an average of 0.6 points, the no-points rate is around 6.58%.
Freddie Mac's Chief Economist Frank Nothaft attributed the increase to inflation fears that led to higher interest rates. "In the first quarter of 2006, it appears that economic growth picked up relative to the last three months of 2005, "Nothaft said. "There is concern that the continued high level of energy cost may lead to inflation in other sectors of the economy." He added that Freddie Mac's forecast for the year is for a 3.8% economic growth, which is above the 3.2% seen last year. This, according to Nothaft, might lead to more Fed hikes than had been previously anticipated. "If that is the case, mortgage rates may continue their gradual upward trend," he said.
Freddie also reported 15-year fixed rates jumped 10 basis points to 6.10%; 5/1 hybrid ARMs rose to 6.11% from 6.02%; and one-year ARMs were up six basis points to 5.57%.
With the sharp increase in mortgages, application activity is anticipated to have slowed last week. Lehman analysts anticipate a drop towards 1500.
The sharp increase in mortgages is also likely to lead to downward revisions regarding prepayment speeds, possibly for April, but more likely May. Currently, speeds are expected to decline around 10% for April as there is a lower day count, and increase about 15% for May.
The March prepayment reports were released last Thursday evening, after ASR's deadline. Speeds for the report were expected to show a sharp increase of close to 30% for 30-year FNMA 5.5s and lower, and about 20% for higher coupons. Meanwhile, GNMA speeds were predicted to jump 15% to 20%. Paydowns are expected to increase to over $40 billion from $35 billion. Influencing speeds for March are four additional collection days versus the previous month and stable refinancing activity - the MBS Refinance Index averaged 1633 in February versus 1666 in January.
On Tuesday, UBS analysts said that based on their expectation of higher mortgage primary rates and the declining mortgage refinance application volume, they have lowered their projections for the May prepayment report. They also expected prepayments to increase 20% to 25% in March, followed by a decline of 10% to 15% in April
Meanwhile, JPMorgan analysts also expected considerably higher speeds in the upcoming April report, attributing the rise to seasonal factors that are usually 20% to 30% higher for March compared to February. They also said that the additional calendar days suggest an extra 18% increase. Therefore, JPMorgan analysts expected discount speeds to increase by 35% and premiums to pick-up less by 25% to 30% in March's prepay numbers. Overall, analysts estimated agency fixed-rate paydowns to be up 30% to $45 billion.
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