The backdrop of this week's mortgage activity continued to be about the European Union and refi.gov

This week, however, worries about the European Union kept investors more risk averse versus last week's risk on action. With yields slightly lower and supply manageable, there was buying in production coupons from a wide range of investors including banks, insurance companies, overseas, money managers, fast money and, of course, the Federal Reserve into mid-day Wednesday. Premium coupons, meanwhile, were pressured by selling on various headlines related to changes to Home Affordable Refinance Program (HARP), including a midweek meeting between the Federal Housing Finance Agency (FHFA) and originators.       

Wednesday around mid-day, however, and continuing through Thursday' session, flows started moving back up in coupon as apparently "no news was deemed good news" as no headlines came out from the purported meeting. In addition, there were several Wall Street MBS research reports out saying that premium coupons have adequately priced in the potential pickup in prepayments from the expected tweaks to HARP.  

For example, Deutsche Bank Securities analysts said these coupons seem to have properly repriced for the HARP risk and "it's time to start scaling back in. In fact they believed that MBS have repriced for more substantial changes than is likely to occur which sets up the sector "for a little spread rally."

Bank of America Merrill Lynch (BofA Merrill) also thinks that the net impact of the HARP tweaks will be less than what the market has feared and that high coupons should remain slow enough to provide an attractive duration-adjusted yield.

Comments Thursday evening from Fed Governor Daniel Tarullo buoyed buying from money managers in 3.5% through 4.5% coupons on Friday and into mid-day they were leading on the stack.  In his speech regarding the jobs market and high unemployment level, he highlighted the housing market noting that it was "like an albatross around the necks of homeowners and the economy as a whole, with millions of underwater mortgages, a staggering inventory of foreclosed homes, and depressed levels of sales."

He stated he favored the purchase of additional buying of MBS beyond reinvestment of paydowns. A large-scale MBS purchase program, he said, would particularly benefit the housing market as it would increase demand for MBS, which in turn would lower their yield and then put downward pressure on mortgage rates. This would help stimulate new purchases, as well as, help homeowners refinance.  

The supply/demand dynamics resulting from the Fed's buying were more favorable in the latest period as a result of lower supply as mortgage rates have backed up. For the period Oct. 13 through Oct. 19, the Fed bought $5.85 billion in agency MBS which equates to $1.17 billion per day. 

Over this same period, mortgage banker selling totaled $8 billion, $1.6 billion per day, or 73% of the supply. This was up from 72% in the prior week and 58% in the first week of their buy program when supply was particularly heavy due to the sharp drop in mortgage rates at the time.    

In other mortgage activity, GNMA/FNMAs gained on real money and overseas support with the 4.0 swap pushing toward three points; FHLMC Golds/FNMAs also saw better support mid-week on real money buying, while 15s mostly lagged 30s with the curve flatter. The specified pool sector was active particularly with Treasury BWICs with a couple of sessions in the over $1 billion area, while demand was good from structured desks and other investors seeking call protection.

Meanwhile, as previously stated, mortgage banker selling continued to ease off as mortgage rates have backed up. Supply averaged $1.6 billion per day - consisting primarily of 4% coupons, down from $1.8 billion in the prior week. MBS volume averaged 102% through Thursday, according to Tradeweb's experience, unchanged from previously. 

The sector basically treaded water over the week as indicated by various measures. Excess return versus Treasuries on Barclays Capital's MBS Index was at seven basis points over month-to-date, up three basis points from Oct. 14. The sector continued to lead ABS (negative 18 basis points) and CMBS (negative 79 basis points). Meanwhile, the 30-year current coupon yield held steady in the low 3.30% area with the spread to 10yr notes and swaps little changed at 115 basis points over and 96 basis points over, respectively.   

Prepayment Outlook

Speeds are currently projected to increase around 5% on average for October. The largest percentage increases continue to be 5% coupons and lower. Factors influencing activity include a lower day count at 20 from 21, as well as, lower refinancing activity with the MBA's Refi Index down 4% on average for September versus August despite mortgage rates in Freddie Mac's survey averaging 4.08% compared to 4.26%. Paydowns are currently estimated in the $108 billion area; month-to-date gross issuance stands are $55.1 billion.

Looking further out to November and December, speeds are seen increasing less than 5%. In particular by December, 5% coupons and below are predicted to be flat to lower, with super premiums recording modest increases.

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