Mortgage flows were mixed last week as the news featured a Federal Open Market Committee meeting, the Treasury Quarterly Refunding announcement and January non-farm payrolls.
Volume was light at the start of the week as participants waited for the FOMC's statement. Committee members voted to drop the term "measured," but with the potential inflation risks they said, "some further policy firming may be needed." Strong selling followed with both real and fast money dumping 5.5s and 6s to move down in coupon as the curve flattened. Specifically, 6s were hit by strong selling on Tuesday, totaling over $3 billion. A servicer apparently made a large purchase of FNMA 5s from 6s. There is some divergence in opinion, however, on whether it occurred before the FOMC news or after.
The 2s/10s curve inverted Wednesday as a result of the refunding announcement. The Treasury reported a $48 billion package consisting of $21 billion in three-year notes, $13 billion worth of 10-year notes and $14 billion in bonds. The auctions occur starting Tuesday through Thursday this week. The inversion and higher yields resulted in heavy two-way flows with continued down in coupon movement in mortgages and selling out of 15s into 30s. Hedge funds and banks were better buyers, money managers were better sellers while servicers were mixed. Meanwhile, 30-year 5.5s were the worst performing coupon. JPMorgan Securities suggests this coupon has the worst short-term technical outlook as supply remains heavy and 6s become the coupon of choice for CMOs. In early trading on Thursday, mortgage flows were quiet with prices and spreads holding in a narrow range as investors waited for Friday's employment report.
Missing last week was overseas support as Chinese investors were out for Chinese New Year's celebrations. They were expected back last Friday and are anticipated to be better buyers at current yield levels. Originator supply has started to pick up and was close to its $1 billion per day average level. Supply has been focused in 5.5s and 6s.
February outlook less positive than January's
Mortgages did not get off to a good start for February. However, they had a great January, providing 43 basis points in excess return, according to Lehman Brothers. The outlook for February, though, is less certain. While the supply technicals remain favorable, along with the Street short, valuations are seen as tight and volatility has the potential to move higher as the Federal Reserve's decisions are seen as becoming more data dependent.
Analysts are mostly neutral.
Credit Suisse analysts say it is maintaining a "cautiously neutral stance" on the sector. While they acknowledged that last week's events had the potential to widen spreads, the "continued positive momentum towards tighter spreads underscores risks of shorting MBS today."
In midweek research, JPMorgan analysts said they were maintaining a neutral near-term outlook, but will look to sell into strength. Their "basis outlook is no longer tactical but looking to set longer term shorts as there is greater clarity that Fed funds will be above 4.75% for a protracted period."
Bear Stearns analysts also held neutral, saying if rates continue to move sideways the sector should continue to see better buying. But they warn investors to go in with their eyes open, given risks such as curve inversion and higher volatility, which could widen spreads.
Purchase and refi indexes fall
Mortgage application activity declined 5% overall for the week ending Jan. 27, despite steady mortgage rates during the week. According to the Mortgage Bankers Association, the Purchase Index dropped 8% to 435.7, while the Refinance Index was off just 1.5% to 1747.2. As a percentage of total application activity, refinancings were little changed at 43%, versus 42.8%. ARM share rose 1% to 30.5%.
Mortgage rates backed up sharply last week in response to the market selloff. In the past two weeks, the 10-year Treasury yield has been up over 20 basis points. According to Freddie Mac's survey, the 30-year fixed rate mortgage rate averaged 6.23% for the week ending Feb. 3, versus 6.12% previously. This is slightly less than was expected, but is at its highest level since the end of December, when it averaged 6.22%. In other programs, the 15-year fixed rate also jumped 11 basis points to 5.81%; the 5/1 hybrid ARM rate gained 12 basis points to 5.87%; and one-year ARM rates reported in at 5.33% versus 5.20% previously.
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