With the mortgage index dipping into discount price territory, relative value is currently based on turnover expectations and not call risk, analysts said.

"Whether mortgages are rich or cheap is now simply a question of turnover expectations," said JPMorgan Securities in a recent report. "There has been a high degree of uncertainty around discount MBS durations. As a consequence, until there is incontrovertible data to the contrary, it is natural for the market to trade discounts to conservative turnover assumptions (especially with hedge fund selling and some bank liquidation)."

The last time there was significant data on turnover and "lock-in" was 1994, when the Fed tightened in a much weaker housing market and when borrowers did not have much accumulated equity. If mortgages turn over more rapidly than in 1994 then mortgage spreads will eventually tighten dramatically, JPMorgan believes.

Turnover speeds this summer are expected to be significantly higher compared to those seen in 1994 or potentially even 2000. JPMorgan predicts baseline turnover might double 1994, citing the U.S. Census Bureau data on existing home sales, which is now near an all-time high. In 2003, housing turnover was at roughly 8.6% for the whole market and is at above 9% for this year.

With accelerated housing turnover speeds expected, analysts are questioning whether this is tied to quickly seasoned 2003 production or more of a general trend.

With refi loans making up a large portion of lower-coupon 2003 collateral, it is easy to say this should season more rapidly than brand new TBA collateral, which is comprised of a high number of purchase loans, said Citigroup Global Markets. The theory is that refi borrowers have spent more time in their homes, so these loans have a head start on seasoning. However, there are compelling arguments to the contrary. The first is that by refinancing, homeowners may be saying that they do not plan to move in the near term. This may especially be the case for borrowers not opting to move into hybrid ARMs.

Citigroup said that loan purpose concentrations were not as extreme as in past refinancing waves, but speeds imply that a strong housing market may outweigh the impact of loan purpose on turnover. Aside from this, the differences in seasoning might be a function of whether the housing market continues to flourish. Even the seasoning of brand new purchase loan 5s might be comparatively quick if homeowners can trade up and take advantage of the increasing equity in their homes.

Freddie Mac expects home sales to reach a record 7.29 million this year, which is marginally higher than sales in 2003, the agency said in its May economic outlook. This is more than the record 7.27 million Freddie Mac forecast in April. Deputy Chief Economist Amy Crews Cutts said rising home sales could happen despite a decline in Freddie's 2004 forecast for total originations. The GSE predicted a drop from $2.8 trillion to $2.4 trillion. Sales are predicted to stay robust due to purchase originations rising to record highs this year, counteracting a projected drop in refinancing, said Crews Cutts. Also, the National Association of Realtors is expecting that home sales will remain at near-record levels in the short run and then dip to levels that are still strong historically.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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