Last week got off to a slow start as investors remained nervous about the credit markets, but it ended on Wednesday with the favorable core CPI news, the Fannie Mae Mega report for May, and an improved tone in credit derivatives. Treasurys rallied and real and fast money were strong buyers - particularly in 5s and 5.5s - which was carrying over into Thursday morning.

The Fannie Mae Mega report for May stimulated heavy buying in FNMA 5s. The GSE reported that $26 billion in FNMA 5 Mega pools were created in May and follows on a total of $24 billion created in March and April versus total production of just over $22 billion so far this year, according to reports.

The roll remains firm and has strengthened, and is "extremely attractive," said Bear Stearns in its weekly research. Bear analysts believe accounts should roll positions out to August if they can. They note that Bank of America's March 31 10-Q shows $35 billion in outstanding forward positions in MBS that settle as far out as July (see story p.12).

Previously, in large BofA forward positions in 2003 and 2004, "the dollar roll eased in roughly the last month that the bank indicated that its trades might settle," Bear analysts wrote. Based on this, Bear analysts said the roll is likely to remain strong into July then weaken afterwards.

A sign that the roll is about to weaken will be the reappearance of the recent mega-pools in the mix available for settling the dollar roll trades, analysts added.

Another analyst cautioned, however, that current levels and a further rally may initiate some selling of FNMA 5s from investor portfolios, putting most of the originator supply into the 5% coupon.

Mortgage application activity falls nearly 11%

Mortgage application activity more than wiped out the previous survey's gains, according to the latest Mortgage Bankers Association survey. Last week the Purchase Index dropped 11% to 469, while the Refinance Index was down 10% to 2037. As a percentage of total applications, refinancings were essentially unchanged at 39.3% versus 39.2% in the previous report. ARM share fell to 33.9% from 35.3%.

Freddie Mac reported lower mortgage rates for the week ending May 20 in its latest weekly survey. The 30-year fixed mortgage rate declined to 5.71% from 5.77%, the lowest rates have been since February, when they averaged 5.69%. The 15-year fixed rate also slipped six basis points to 5.27%; 5/1 hybrid ARMs reported in at 5.07%, 14 basis points lower; and one-year ARMs were up three basis points to 4.26%.

The continuing low rates will keep the housing industry afloat, said Freddie Mac's Chief Economist Frank Nothaft, adding that both new and existing April housing sales are expected to come in at or near historical levels. "It is remarkable how mortgage rates have remained so low for so long," Nothaft said. "But as long as inflation is held in check, there is little or no pressure to push mortgage rates higher. And at the moment, despite high fuel prices, core inflation does indeed seem to be a nonevent."

Looking ahead to this week's refinancing activity, expectations are for the Refinance Index to hold in the low-2000 area.

May prepayments expected to be slightly lower

Currently, the outlook for May prepayments is for 30-year 4.5% coupon and 5% coupon, and 2004 5.5% coupon and 6% coupon speeds to hold essentially flat to slightly faster, while other coupons and vintages should slow around 5%. Factors influencing the May report include day-count - unchanged from April at 21 days - and an average 5.86% lagged mortgage rate in May versus 5.80% in April, according to Morgan Stanley. At this time, June speeds are projected to increase about 10%. For this report, day-count totals 22 days and the average lagged mortgage rate is 5.80%.

(c) 2005 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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