Last week started off with MBS lagging as the slight gains in Treasurys and the lack of data provided an excuse for investors to continue to take profits after the strong gains made in April and into mid-May.
Through midweek, mortgage volume was running about average with a supportive tone brought on by recent cheapening.
Last Tuesday's sharp sell-off was driven by a better-than-expected retail sales report as well as increased inflation concerns reported through import prices and several Federal Reserve comments provided an opportunity for participants to take advantage of the cheaper prices.
Overseas investors got the ball rolling, and real and fast money piled in. By midday, buyers reportedly outnumbered sellers by 3:1. The afternoon brought servicer and convexity related selling, which took spreads off their tights to close unchanged on the day.
Better buying continued into Wednesday with spreads several ticks tighter by midday. Also contributing to MBS gains was strengthening in dollar rolls, helped by Libor declines. For example, the drop on FNMA 5s was at 8.5 on Wednesday morning, up from 6.75 as of Tuesday's close. Rolls in the belly of the stack were at 9.375 up from 7.875 to 8.000.
In other mortgage-related activity, 15s outperformed 30s on Monday, but weakened on Tuesday and Wednesday, while GNMA/FNMA swaps were flat to slightly weaker on better selling. Originator selling picked up slightly, though remained limited - averaging $1.6 billion per day through midweek. Supply consisted of 5.5s and 6s.
MBS are off their decent month-to-date gains following the recent better selling. According to Lehman Brothers, the MBS Index is lagging Treasurys by one basis point through May 13 compared with outperforming by 32 basis points through May 11. Competing sectors remain in positive territory with the ABS Index up 59 basis points, CMBS at 91 basis points and U.S. credit at negative 21 basis points.
Mortgage Outlook
Street analysts were neutral to positive on the mortgage basis last week. RBS Greenwich Capital, for example, returned to a short-term neutral on the basis saying that while mortgages still look cheap historically, they richened significantly since mid-March.
On top of that, the typical supportive time of the month for the sector (month end, payrolls, paydowns, Class A pool allocations) has passed. UBS analysts stayed with a neutral recommendation, saying that mortgages appear fair on their model.
Citigroup Global Markets analysts stayed with an overweight to agency MBS, although they acknowledged some concern considering the strong performance the sector has had and suggest active vigilance. Specifically, they said that, "eternal vigilance is the price of being overweight MBS."
Meanwhile, Barclays Capital analysts turned positive on mortgages from neutral on expectations that they will tighten further. Factors influencing their upgrade included the belief that volatility should remain low with the Fed seeming to have finished its easing cycle as well as the improving liquidity as illustrated by the strong results from recent Term Auction Facility and Term Securities Lending Facility auctions. Other factors are the growing business opportunities and looming capital surcharge reductions for the GSEs.
Mortgage Application Activity Gains
As expected, lower mortgage rates stimulated mortgage application activity in the week ending May 9. The Mortgage Bankers Association reported that the 30-year fixed contract rate fell nine basis points to 5.82% and the one-year ARM contract rate dropped 17 basis points to 6.6%. This helped propel the Refinance Index 6.5% higher to 2422.1. The Purchase Index held relatively steady at 378.5 compared to 381.3 in the previous report. As a percent of total applications, refinancing share picked up to 48.7% from 47.1%. ARM share was also higher at 8.3% versus 6.8% previously.
Speeds are currently expected to slow about 1% to 2% in May with the 2007 and 2006 vintages continuing to experience the largest percentage declines. Contributing factors include one less collection day in May versus April and lower refinancing activity on average. The MBA's Refinance Index averaged 2411 in April compared with 2919 in March.
Looking ahead to June and July, speeds are expected to increase just 1% to 2% for conventionals and slightly more for GNMAs. These speeds should be boosted by seasonals and steady to higher day count (21 days in June and 22 in July).
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