Mortgages experienced active two-way flows last week, as the start of the week saw better buying on the Treasury sell-off. As has been stated many times, mortgage players have plenty of cash currently, and tend to be strong buyers when the market sells off. Particularly active were insurance companies, hedge funds, and overseas banks. Month end buyers were not particularly noticeable as the MBS Index lengthened just 0.06 years on Dec. 1.
As the week progressed, originator selling picked up with Tuesday through Thursday averaging $2 billion per day. Servicers and pension funds added to the selling fray. The continued sell-off in Treasurys is starting to create some uncertainty in the market regarding extension risk and about where to hedge.
In comments from JPMorgan Securities last week regarding extension risk, they said that unlike Q303, originators don't have significant long positions, so analysts don't anticipate a similar widening event. At the same time, analysts estimate duration extension will be gradual. JPMorgan analysts report they expect that if FNMA 6s decline to a high 101-handle, there could be a pick up in duration selling. Another trader suggested the market would need to sell-off 25 to 30 basis points before convexity starts to become an issue.
Over the week ending last Wednesday, spreads were flat to slightly wider on 30-year FNMA 4.5s through 5.5s, and two and six basis points tighter in 6s and 6.5s, respectively. Meanwhile, 15s were one to two basis points firmer in the lower coupons, and four to six basis points better in 5s and 5.5s.
Purchase activity holds steady; refis decline
Application activity was mixed for the week ending Nov. 26, according to the Mortgage Bankers Association. On a seasonally adjusted basis, the Purchase Index was little changed at 460 versus 463 previously, while the Refinance Index was down 12% to 1912. This was in-line with expectations. On an unadjusted basis, purchase activity dropped 34%, and refinancings plunged 39%. As a percentage of total mortgage applications, refinancings declined to 46.4% from 48.4%. ARM share also fell to 32.3% versus 34 % previously.
Fixed rate mortgage rates gain
Freddie Mac reported modest gains in fixed rate mortgage rates for the week ending Dec. 3. The increases were no surprise given the recent bear flattener. The GSE reported 30-year fixed rate mortgage rates averaged 5.81%, up nine basis points from the previous week. The 15-year fixed rate mortgage rate reported in at 5.23% versus 5.15% previously. The one-year ARM rate, meanwhile, was unchanged at 4.19%. Looking ahead to this week's report, the Refinance Index is expected to hold below 2000 on a combination of higher rates and year-end holidays.
Meanwhile, last week both the Office of Federal Housing Enterprise Oversight and Freddie Mac reported strong gains in home prices for the third quarter.
OFHEO reported average home prices in the country for the third quarter increased 12.97% from 3Q03. For the quarter, it was a 4.62% gain, equating to an annualized rate of 18.48%. Freddie Mac also released its findings and reported that its quarterly Conventional Mortgage Home Price Index jumped 12.4% from the third quarter of last year through the third quarter of 2004 (See related story on p. 16).
November prepayment outlook
Freddie Mac and Fannie Mae will release November prepayment reports this Monday. Speeds are expected to hold fairly steady. The near term outlook also anticipates little change in speeds for December, before slowing around 10% to 15% in January.
In comments from JPMorgan, analysts expect the December prepayment report to have the most pronounced acceleration to be in 5.5s and to a lesser extent in 6s. This basically mirrors the previous month's prepayment pick-up, analysts say. This is why researchers expect seasoned collateral and higher coupons to remain tame, with the MBA Refinance Index staying in the low 2000 level. Analysts also predict that prepayments for seasoned vintages and higher coupons to remain below expectations.
JPMorgan expects 2003 5s, in particular, to be near 11% CPR while predicting that 2003 and 2002 6s would remain around 30% CPR. Meanwhile, analysts believe that 2002 6.5s will be barely north of 35% CPR. Agency fixed-rate paydowns might rise by 4% to 5% next month to approximately $60 billion, researchers say.
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