The mortgage-backed bond market was a bit unsettled last week, sources said, as emerging market concerns sparked increased Treasury buying and mortgage players continued to absorb the Federal Reserve's announcement a week earlier that it had adopted a tightening bias toward interest rates.
In short, spreads have widened markedly since the beginning of the month. According to one MBS trader, the current interpolated coupon showed that mortgages widened from 118 basis points over Treasurys on May 12 to 139 basis points over on May 24 - a 21 basis point widening in about a week and a half.
"Now we're back in a couple of basis points from that," said the trader, "but we're still pretty cheap compared to Treasurys. On the other hand, swaps also widened out - not quite as much - about 17 basis points." MBS spreads widened out early in the week in tandem with debt swap spreads, although they tightened up a bit as the week closed.
The main concern for most investors is extension risk. With mortgage rates having steadily climbed since April before leveling off last week - not to mention a rate hike potentially around the corner - many MBS holders are reducing and restructuring their portfolios.
At the same time, the spread widening has also brought back some investors ot the market. Sources said a number of money managers who had been idle finally entered the market and bought bonds last week, reflecting that demand for mortgage-related product - particularly commercial mortgage deals - is still present.
"There is good demand for several large CMBS deals that have come in," said an MBS portfolio manager. "There are bids for this paper, so the market is certainly firming up a bit. The swap market is tightening as well, and the GMAC deal, which had problems early on, priced at 130 over, and was beginning to trade in the secondary [market] at around five basis points tighter than that."
While rate concerns are certainly on the minds of investors, there's no clear consensus on when the first rate hike might come. Thus, for the time being market players can expect some ups and downs as different economic numbers are released and the long bond's yield changes.
Michael Youngblood, managing director of mortgage research for Banc of America Securities, said recent differences in rate indicators provide "an elegant illustration of how divided the markets are now in response to the Fed's doing what many expected it to do."
Though spreads widened last week, there was still a healthy hunger for CMBS product. Lehman Brothers Inc. sold a total of $1.7 billion in CMBS, $1.6 billion of which was senior bonds. GMAC Commercial Mortgage Corp.'s similar 10-year issue was said to have trouble in the market early on but priced at a spread of 130 basis points over Treasurys. Secondary trading on that deal mid-week was said to have begun at 126 over.
Other deals that priced last week were the Prudential/Heller Financial transaction, the Morgan Stanley deal for the One New York Plaza building, and a Paine Webber/Merrill Lynch conduit deal. Expect to see a large CMBS deal from GE in the next few weeks, underwritten by DLJ, as well as significant deals from RFC and Salomon Smith Barney. - AT
