As the yield on the 30-year Treasury bond surpassed the 6% mark last week, mortgage market sources reported a significant sell-off of MBS paper and growing concerns about liquidity.
"Across all our desks we have had complaints about liquidity in the ability to both buy and sell bonds," said Michael Youngblood, managing director of mortgage research for Banc of America Securities. "[But] it is not as if the market is locked up with interest rate fears and all participants are moving in one direction."
According to Youngblood, the month-to-date total for agency issuance has taken a major plunge: Fannie Mae, Freddie Mac and Ginnie Mae have issued $9.6 billion in pass-throughs month-to-date for June. Through the same date in May which clearly was not the highest issuance month of the year - the three agencies had issued $14.7 billion in pass-throughs.
Similarly, in agency Remics, there has been $3.4 billion in issuance for June month-to-date, relative to $18 billion last month at this time, representing a significant shortfall of Remic issuance.
Additionally, the Federal Bank Reserve of New York reported last week that net dealer positions in MBS are only $15.2 billion, which represents less than one day's transaction volume in mortgages.
"So the Street is carrying enough inventory to sell in one day," Youngblood said. "Back in the peak of the market, in April 1993, the Street carried over three weeks of inventory. So there is real evidence for liquidity concerns."
Sources also said spreads were slightly wider on the week: on current coupon Fannie Mae bonds, spreads were eight basis points wider on an OAS basis, and on 7.5% Fannie Maes, spreads were 13 basis points wider.
"This reflects fears of perspective lengthening of mortgage average lives," Youngblood added. "This also reflects the relatively high level of interest rate swap spreads as a proxy for credit risk spreads, which are unlikely to decline given the prospects of Fed tightening."
In addition to concerns about extension risk, many market players expressed the concern that empirical durations will lengthen so that they begin to concur with effective or model-based durations, which are roughly a year longer.
Therefore, the market was steadily pricing in the consequences of higher yields, slower prepayments, and therefore, longer durations.
One MBS source predicted that the market might see as much as 17 basis points more widening in the current coupon Fannie Maes, a level where the market was at near the end of 1998.
"There are lots of sellers out there," said another MBS trader. "But there also seems to be a lack of origination. Even though Treasurys drifted lower, there are not a lot of originators selling. There are more pair-off buy-backs, where guys have overestimated their supply and need to buy some back. That might actually help the market."
Another researcher mentioned that the market was fairly quiet last week "except for some mortgage bankers selling." Though there was not a deluge of supply, "the Street absorbed the selling from the mortgage bankers, which was moderately heavy."
"Bankers sell a bit when the market falls in line with the Treasury market," the source added. "Buyers are quiet this week, and mortgage banker flows were the dominant retail flows in the market." - AT
