The markets were rather quiet last week, althought participants flooded back from the long weekend to higher rates and a flatter curve. The flatter curve was a reaction to the much-stronger-than-expected employment report.
The March report was above expectations in all categories: nonfarm payrolls at 180,000 versus a consensus reading of 165,000, and unemployment rate at 4.4% versus 4.6%, hourly wages at a 0.3% gain compared to expectations of 0.2%, and a work week at 33.9 hours versus 33.8. In addition, nonfarm payrolls were revised higher by 32,000 in the previous two months. On the Good Friday, holiday-shortened session, the 10-year Treasury dropped 19/32nds, while the yield increased 7.7 basis points to close at 4.753%, its highest level since Feb. 22. In addition, the yield curve flattened with the spread between two-years and 10-years at one basis point versus 5.5 basis points before the release.
Through early trading on Thursday, the 10-year yield traded between 4.70% and 4.75% over the week. The spread between two-year and 10-year Treasurys held to slightly over two basis points which was less steep. Partly contributing to a narrow trading range last week was the limited economic news. Early week flows were stymied initially by the wait for Wednesday's Federal Open Market Committee minutes from the March meeting, and not much pickup was seen afterward. The minutes recorded a much less dovish tone than was suggested by FOMC's last statement. Following the release of its statement at the March 20 meeting, the market seemed to interpret that the FOMC intended to reverse its tightening stance. However, more clarity in their minutes suggest that tightening does remain a real possibility. For example, some members insisted that more rate hikes "might prove necessary" and "all members agreed the statement should indicate that the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected." Still, members agreed the wording of the policy statement shouldn't be limited to a tightening stance, possibly on concerns about underlying issues in various sectors of the economy that could undermine growth.
Despite the higher yield levels, the outlook for a range-bound market, and the low volatility for the near term, providing a more attractive investment environment for MBS, volume was below normal, but two-way, last week. Weighing on the market early in the week was very heavy originator selling on Monday that totaled between $2.5 billion and $3.0 billion. For the week, daily selling averaged over $1.5 billion. One particularly bright spot was the increasing presence of overseas buying last week.
Not all was dull, however, was last week in MBS. In particular, several rolls in the 30-year sector strengthened, especially the FN 5 roll (as well as the FG 5 roll). FN 5 roll opened the week at a firm three ticks and at one point in the settlement cycle rose to over 5 ticks. Also showing strength in rolls were FN 7s and FN 6s. When the FN 5 roll started firming over a week ago, there was some thought that one or two dealers were pushing the market around to extract some added juice from pay-ups on pools. But last week's activity appeared to dispel that notion, and there appeared to be real shorts in the market. The pop in rolls is seen as a positive for the sector, and is an additional factor that should help draw overseas interest.
Mortgages are performing well both month to date and year to date against both ABS and CMBS sectors, according to Lehman Brothers. The MBS Index is outperforming Treasurys by 11 basis points month to date and year to date. The ABS Index is flat month to date, and is down nine basis points year to date, while CMBS is up two basis points for the month, but down 15 basis points year to date. Meanwhile, the Corporate Index has shown recovery and is outperforming by 19 basis points so far in April, while it is back up to 18 basis points over for the year.
Mortgage outlook
This week's data is front-end loaded with two key releases in particular that the market will be looking to for direction. They are retail sales on Monday and CPI on Tuesday. Other data include: Business Inventories and the Empire State Manufacturing Survey on Monday; Housing Starts and Industrial Production/ Capacity Utilization on Tuesday; and Leading Indicators and Philly Fed Survey on Thursday. It's a busy week, too, for representatives from the Federal Reserve. St. Louis' William Poole, Philadelphia's Charles Plosser and Dallas's Richard Fisher will all be talking at various times on Monday. Tuesday holds another appearance by Plosser, along with New York's Timothy Geithner. On Thursday, San Francisco's Janet Yellen and Board Governor Frederic Mishkin will also put in appearances. Noteworthy for next week - especially on expectations that loan underwriting standards are being tightened - is the release on Monday of the Federal Reserve's quarterly Senior Loan Officer Survey.
There are two events specifically of interest to the mortgage market this week: 48-hour notification beginning Tuesday for Class C (30-year GNMAs) and on Friday for Class D securities. Rolls appear uneventful.
The near-term view in mortgages appears favorable. Positives include potential for better overseas buying with yield levels higher as well as volatility staying low - although more volatility is seen around key economic data releases. Still not out of the clear are subprime mortgages and the generally slow housing market. Barclays Capital analysts say that they are holding their "tactical overweight" on the mortgage basis. Reasons for the bias include their models which show the mortgage basis as 4.7 basis points cheap; the expected pickup in demand, including from overseas investors, as a result of the higher yields as well as the increased carry that is making MBS more attractive for investors. In the longer term, Barclays analysts are neutral on mortgages, as they believe the Federal Reserve will have to hike rates as yearend approaches.
This is currently not priced in, but as it is, analysts expect overseas demand would begin to wane.
UBS analysts scaled back on their overweight last week because of the recent strong performance in MBS and because the spread between the perfect current coupon mortgage and the average of the five- and 10-year swaps is at 66 basis points, its tightest since late February; as well as the strong net new agency issuance in the first quarter.
Bear Stearns analysts, meanwhile, say they are neutral-to-negative on nominal spreads in MBS, but slightly bullish on option-adjusted spreads. They believe there is risk of rising volatility that makes holding MBS less palatable. They recommend investors hedge the volatility risk, which should leave investors long on the OAS.
Application activity mixed
Overall, mortgage application activity was down just 0.4% on mixed application activity for the week ending April 6. According to the Mortgage Bankers Association, the Refinance Index declined 4% on a seasonally adjusted basis to 2015, despite stable mortgage rates. This was the fifth straight week of declines in refinancing activity since it peaked at an 18-month high for the week ending March 9 at 2312. A year ago, the Refinance Index stood at 1532, with 30-year fixed mortgage rates moving toward 6.50%. The slowing in activity is attributed partly to the holidays last week as well as to a tightening in lending standards.
Meanwhile, the Purchase Index rose 2.7% to 413.8. The year-ago level on purchase activity was similar at 418.
As a percent of total applications, the refinancing share fell to 42.8% from 44.5%. ARM share declined to 18.7% from 19.2%. This is the lowest ARM share has been since July 2003.
Mortgage rates move higher
With the employment report sell-off, it's no surprise that mortgage rates were higher in Freddie Mac's latest survey. The 30-year fixed mortgage rates recorded the largest increase at five basis points to 6.22% for the week ending April 13. This is the highest mortgage rates have been since the week ending Feb. 23, when they also were at 6.22%. This is also the same level that mortgage rates averaged in the first quarter, says Freddie Mac chief economist Frank Nothaft. A year ago, mortgage rates were at 6.49%.
Meanwhile, 15-year fixed mortgage rates and one-year ARM rates rose three basis points to 5.90% and 5.47%, respectively. Finally, five-year hybrid ARM rates increased to 5.93% from 5.92%.
"Mortgage refinancing still remains strong," said Freddie Mac's Nothaft. "The 30-year FRM rate has remained below 6-1/2 percent since mid-August 2006, which helps explain why the share of total mortgage applications for refinance has remained above 40% since last August." He added that among those borrowers who are choosing to refinance now, a large share are doing so to avoid an adjustment to their monthly payment as the initial period on their adjustable-rate loan expires or to extract equity through a cash-out refinancing. In the fourth quarter of 2006, 84% of borrowers who refinanced their prime conventional loans increased their loan balance by more than 5%, totaling more than $70 billion in equity extracted. Freddie Mac is expecting similar numbers for the first quarter of this year. - Sally A. Runyan/IFR MortgageData
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