A sell-off this week was boosted by a risk-on mentality based on more optimistic expectations regarding the European Union and stronger-than-expected economic data.
Additionally, there was also the coordinated policy action announced on Wednesday by six of the major central banks, which included the Federal Reserve. The joint action is aimed at lowering pricing on existing temporary U.S. dollar liquidity swap arrangements to ease strains in the financial markets.
Through mid-week, mortgages saw active buying from money managers, real money, hedge funds, the Fed, month-end indexers, and others on the order of 4:1 (versus sellers) as 10-year note yields backed up nearly 10 basis points from the prior Friday's close to a more palatable 2.07%.
Additionally, the increasing odds of additional MBS buying from the Fed through a QE3 program drew investors to the table. Market participants think that the Fed could buy as much as $500 billion.
Morgan Stanley analysts believe there was a strong possibility of more Fed MBS purchases and estimated $250 to $300 billion in the second half of 2012 Meanwhile, Deutsche Bank Securities Managing Director Steven Abrahams stated in mid-week research that "the market arguably has priced in 10 basis points of what should be a total of 25 basis points of tightening around this kind of program."
Abrahams added this is a good case for being overweight the sector if the chances of QE3 are better than 50%, which they seem to be.
Friday's employment report was on participants' radar in Thursday's session. This led to mixed flows. After strong gains Monday through Wednesday, profit taking picked up on Thursday, even as 10-year note yields inched higher from hedge funds, money managers, and overseas.
This was partially offset, however, by demand from banks, other money managers and the Fed. Overall, sellers beat out buyers by a reported margin of 2:1.
While non-farm payrolls were in line with expectations, the unemployment rate dropped sharply causing a knee jerk jump in yields to 2.142% from 2.115% at Thursday's close.
Prices, however, moved off their lows shortly afterwards as the drop was associated with a decline in the number of people looking for jobs. At mid-day, 10-year notes were higher nearly 1/2 point on further strengthening associated with a Fed buyback and heightened worries associated with the EU debt crisis.
With prices higher, MBS has been pressured by better selling from real money and others, while origination was approaching $1 billion. Spreads which opened 1-2 ticks tighter to 10-year notes were wider by 3-4 ticks.
Mortgage banker supply, though up from a $1.1 billion per day average in the holiday-shortened week prior to $1.5 billion per day this week, was more than offset by the healthy appetite investors had at the higher Treasury yield and prospects of QE3. It is notable that Fed buying over the week ending Nov. 30 totaled $4.35 billion, absorbing over 70% of originations.
In other mortgage activity, GNMA/FNMA swaps eased lower after hitting highs on Monday with the 4.5 swap, in particular, hitting 3-01+ before moving back below 3 points. GNMAs have benefited for quite some time now from better buying interest related to its zero risk capital weighting for banks, as well as, Basel III rules.
Meanwhile, there was some improvement in FHLMC Gold/FNMA swaps related in part to Fed buying, along with bank and REIT demand for Golds, while 15s mostly lagged 30s despite curve steepening.
Dollar rolls were pressured lower on a combination of year-end balance sheet constraints and investors rolling early. Specifieds were relatively active, especially on Thursday when BWICs from Treasury hit their largest level at $2.1 billion. This weighed particularly on higher coupons and Freddies.
The sell-off helped stimulate volume in MBS this week. Tradeweb's experience for the week through Thursday averaged 118%, up from 68% in the Thanksgiving Day week.
Mortgages generally struggled in November with Barclays Capital's MBS Index underperforming Treasurys by 22 basis points as of Nov. 30. However, the sector recovered from a 67 basis points deficit as of Monday's close as negative convexity risk declined with the backup in yields.
The 30-year current coupon yield ended the month at 3.19% from 3.25% as of the end of October with the spread to 10-year notes and swaps widening to +112 and +97 basis points, respectively, from +108 and +91 as of Oct. 31.
Prepayment Outlook
The November prepayment reports will be released Dec. 4. Expectations are for speeds to increase around 5% or less. Speed increases are relatively uniform across the coupon stack for conventionals, while GNMAs are mixed with 4%s and 4.5% jumping around 12% on average while 5.5s through 6.5s are essentially flat.
Overall MBS paydowns are estimated at $120 billion with MTD gross supply at $108 billion.
