Mortgages experienced active two-ways flows last week by fast-money, servicers, and real-money investors as yields continued rallying in the early part of the week. There was increased convexity buying, particularly from servicers. The mortgage portfolio duration shortening also attracted a wide variety of investors, stimulating interest in the lower part of the coupon stack. Walt Schmidt of FTN Financial said that the MBS Index's effective duration has decreased around a half a year to 3.09 from 3.56, and the market's convexity has worsened as well. Still, states Schmidt, convexity is not as bad as when the 10-year traded in the 4% to 4.4% range. He notes that the 5.5% coupon remains around 80 basis points out of the money to be fully refinanceable. While mortgage rates have rallied significantly in the past two weeks, the risks are still tilted towards extension rather then refinancing, Schmidt said.
There were also technical issues in FNMA 5s and 6s caused by the large Mega pool creation for April, which brought in demand for these coupons. Fannie Mae's monthly report disclosed that the FNMA 6% coupons total over $14 billion while FNMA 5s top $11 billion.
Given these factors, and the need to reduce shorts and underweights, there was good buying across all coupons throughout the week. Additionally, 15s benefited from better support from real-money and relative-value accounts choosing to take a more defensive position.
Originator selling, meanwhile, continues to hold around its $1 billion average per day level. Over the week ending last Wednesday, spreads were three to four basis points tighter versus Treasurys for 30-year Fannie Mae 4.5s through 6s, and two to three basis points tighter in 15-year 4s and 4.5s.
Analysts suggest that investors maintain a defensive posture with a preference towards 15-year MBS, or moving up in coupon into 30-years. The economic data seems to be giving mixed signals about whether the economy has hit a "soft patch" or not, and there are increasing concerns regarding inflation. The market is very reactive currently to any news that could potentially change the course of any Frd action.
Application activity declines slightly
Mortgage application activity declined slightly, according to the Mortgage Bankers Association latest survey. For the week ending April 15, both the Purchase and Refinance Indexes fell 1.6% to 467 and 1870, respectively. Activity was expected to increase, given further declines in mortgage rates. Countrywide Securities said they had experienced about a 6% increase in refinance activity during that week and that purchase activity had also increased.
As a percentage of total application activity, refinancings were little changed at 38% versus 38.1% previously. ARM share also held steady at 35.4% versus 35.8%.
Mortgage rates declined as expected in response to last week's interest rate rally. Freddie Mac's primary mortgage market survey reported that the 30-year fixed rate mortgage rate average 5.80%, down 11 basis points from the previous week and in line with expectations. Mortgage rates were last near this level in early March when the 30-year was 5.79%.
In addition, 15-year, fixed-rate MBS reported in at 5.36% versus 5.46% previously; the 5/1 hybrid ARM fell 9 basis points to 5.22%; and the one-year ARM rate slipped to 4.26% from 4.30%. Given the decline in mortgage rates last week, expectations are for the Refinance Index to move towards 2000.
Freddie Mac chief economist Frank Nothaft said interest rates have been "oscillating with every piece of economic news released lately," adding that the market keeps switching its attention between economic strength and inflation fears. This is why, he said, the past two week's decreasing mortgage rates do not necessarily indicate a trend. "That said, April's mortgage rates are currently lower than those of the previous month," he stated. "And lower mortgage rates will undoubtedly have a positive influence on housing activity."
April prepays expected to slow modestly
Revised expectations regarding prepayments have speeds slowing 10% for 30-year FNMA 5.5s through 6.5s in April, while lower coupons are anticipated to slow 5% or less. Similar percentage declines are predicted for May, while June sees speeds increasing around 5% currently.
In recent comments on the prepayment outlook, UBS analysts noted that in the March to April 2004 period, there was a similar rate pattern experience as this year. This time, however, expectations are for refinancing behavior to be more muted. Analysts attribute this, in part, to the tight trading range in the August to February period that led to borrower ennui. UBS says that when rates are generally flat, homeowners become less active in monitoring mortgage rates or moving to refinance.
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