The mortgage story is once again about technicals. Last week was characterized by limited originator selling - approximately $1 billion per day - and increasing buying support. In particular, there is a returning CMO bid. Money managers were also better buyers, and there was even the beginning of some index buying as the end of the month approaches. Over the Wednesday-to-Wednesday period, spreads on 30-year Fannie Mae 5s and 5.5s were one basis point tighter, while 6s and 6.5s were three basis points firmer. Dwarf 4.5s through 5.5s were in two to three basis points over the period.

Last week also saw increasing interest in the Ginnie Mae sector as a result of the GSE headline risk. Spreads were three to four basis points tighter in 30-year 5s through 6s, and six basis points firmer in 6.5s.

In comments from Lehman Brothers, analysts suggest that mortgages are in a bit of a precarious situation. OAS valuations on lower coupons are at historically tight levels that suggest an upper bound for mortgage outperformance, they added. At the same time, mortgages are still very correlated with overall rates and could widen substantially relative to model hedge ratios in a selloff.

MBS Index extends 0.30 years

According to Lehman, the U.S. MBS Index is set to extend 0.30 years as a result of strong prepayments. This is down from August's record lengthening of 0.36 years. However, it is substantially more than the 0.10 year to 0.12 year average seen earlier this year. The U.S. Agency Index is also forecast to extend a rather large 0.17 years. This is due in part from rule changes. Effective Oct. 1, U.S. agency issues must meet a minimum liquidity threshold of $200 million par outstanding. The U.S. Credit Index is expected to gain 0.10 years, and the U.S. Treasury Index is forecast to increase 0.04 years. Overall, the Aggregate Index is predicted to rise 0.17 years.

MBA Refi Index holds flat

For the week ending Sept. 19, mortgage applications held up firm as rates declined. According to the Mortgage Bankers Association (MBA), the Purchase Index fell 7% to 402, while the Refi Index was barely changed at 2430 versus 2439 in the previous report. As a percentage of total applications, refinancings increased to 51.9% versus 49.9% in the last report. ARM share also rose slightly to 22.7% from 22.4%.

Countrywide Securities had anticipated a higher report based on their activity; however, they were uncertain whether there might be an impact from Hurricane Isabel. That effect seems likely to show up next week if there is a notable increase in the index.

30-Year mortgage rate falls

For the week ending Sept. 26, the 30-year fixed-rate mortgage fell three basis points to 5.98%, according to Freddie Mac's latest survey. Analysts were expecting the rate to fall to 5.95%. Meanwhile, the 15-year fixed-rate mortgage rate was unchanged at 5.30%, while the one-year ARM rate reported in at 3.77%, down four basis points.

In recent comments from JPMorgan Securities, they said that at around 6.0% 30-year no-point rates, they would expect the Refi Index to stabilize in the low 3000s. Lehman is not quite so aggressive in their expectations, noting last week that at current rate levels they expect the Refi Index to be close to 2000 in the coming weeks.

If rates do continue to hold lower and keep the Refi Index firm, it seems likely that speeds in October will be revised higher from current estimates. At this time, consensus is predicting that 2002 Fannie Mae 5.5s will fall 56% to 21% CPR, and fall another 41% in October to 12% CPR. Meanwhile, 2002 6s are anticipated to decline 41% to 39% CPR in September, followed by a 30% decline to 28% CPR in October.

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