Through midweek last week, tapebombs were absent, so the markets reacted to mixed economic data and some earnings news.
The negative headlines included stunningly weak results for the ISM Non-Manufacturing Index on Tuesday, which came in at 41.9 versus analysts' prior expectation of 53.0 as well as a December upwardly revised reading of 54.4. The disappointing results spurred talk of an inter-meeting rate cut by the Federal Reserve if the economic data remain weak before the committee meets again on March 18. Treasurys rallied sharply on the news, while equities plunged 370 points. Wednesday's fourth-quarter Productivity and Cost news, however, was favorable. It showed a rise in worker productivity and a less-than-expected increase in inflation. Equities strengthened on the news, while Treasurys sold off.
The first half of last week saw below-normal volume in MBS with mixed flows. Typically, sell-offs lead to money managers and hedge funds moving up in coupon, while rallies encouraged convexity and leveraged buying in the lower part of the coupon stack.
Overseas investors were light buyers ahead of the Chinese New Years celebrations that began last Wednesday and will last through Feb. 12. Activity in specified pools was quiet with small bid lists circulating. GNMAs/FNMAs were stable for the most part. Meanwhile, 15s lagged 30s as increasing supply weighs on that sector. Levels, however, were seen as attractive despite the supply. Originator selling continued to run at about $2 billion per day on average. Supply remains primarily in 5% coupons and, to a smaller extent, in 5.5%s.
Month-to-date through Feb. 5, Lehman Brothers MBS Index is down seven compared to negative 12 basis points in ABS, negative 141 basis points in CMBS and 10 basis points in corporates.
Analysts mostly had a neutral on MBS last week. For example, JPMorgan Securities moved to neutral on the mortgage basis from underweight partly because wide nominal spreads are expected to attract real money buyers. JPMorgan analysts, like many other Street researchers, have an up-in-coupon bias. Reasons supportive for this bias include increasing supply in 5s and 5.5s, a steepening curve, credit impairment, high LTVs. These factors are expected to limit speed increases in the higher coupons.
Barclays Capital also turned neutral, but from overweight. Some concerns include bank MBS selling as they try to improve capital levels, and looming releases of earnings news from the GSEs, which could be surprisingly low and become another negative factor for mortgage spreads.
Regarding the GSEs, Barclays said that starting in March, Fannie Mae will be reducing the maximum LTV available to borrowers for their loan programs by 5% if the mortgages are located in areas experiencing home price deterioration. Barclays analysts noted that, historically, prepayments for highly leveraged borrowers are slower in weaker housing environments. Back in 2003, only about 4% of FNMA pools had LTVs greater than 80%, they said, compared to nearly 25% by 2007.
"This suggests that there are significantly more credit-impaired borrowers who will display dampened prepayments in the present environment," the Barclays analysts said, adding that from 2004 through mid-2006, the Refinance Index tracked fixed prepayments rather well, although it has since diverged.
Mortgage Applications Rise
Mortgage application activity rose just 3% in the week ending Feb. 1 as mortgage rates rose. In that week, Freddie Mac reported a 20-basis-point jump in the 30-year fixed mortgage rate to 5.68%. According to the Mortgage Bankers Association, the Refinance Index slipped 1% to 5054.0, while the Purchase Index rose 12% to 405.3. Refinancings remain at their highest level since late July 2003. As a percent of total applications, refinancings declined to 69.2% from 73% previously. ARMs were up slightly to 8.8% from 8.6%.
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