FRM Update

August 27, 2018

MBS underperformed Treasuries last week as the Treasury curve continued its flattening trend with the 2’s/10’s narrowing from 25 bps at the beginning of the week to just 19 bps by week’s end.  The 2-year Treasury increased 1.4 bps while a rally on the longer end of the curve sent the 10-year down by 4.7 bps.  Yield spreads for 15-year MBS yield spreads to Treasuries were unchanged while spreads for 30-year MBS to Treasuries widened by 1 to 2 bps.

Activity last week was fairly stable as investors continued to seek the safety of current cash flows as the Fed is expected to be on a steady path of tightening for the foreseeable future.  Seasoned 15-year and 20-year MBS were the most common choices for depositories.

The following represents a summary of the activity last week and themes in the overall sector:

• Seasoned 15-year 2.5s and 3.0s – The flat yield curve and relative value in these coupons has driven investors to this segment. There continues to be a relatively small pay up over TBA for pools with seasoning between 18 to 36 months. In some cases, investors can potentially receive less price volatility and greater stability of cash flows relative to new pools, for a modest trade-off in projected yield.  Please see a recent Strategic Insight discussing the current merits of slightly seasoned, below par 15-year MBS.
• 15-Year 3.5s and 4.0s – New or recently issued pools.
• 20-Year 4.0s – Seasoned pools with WAMs ranging from 190-200, an alternative to new issue 15-year MBS with higher premiums.
• Non-TBA pools – Relocation, seasoned high LTV typically offer higher turnover
• FNMA DUS and Freddie K’s – The focus for FNMA DUS has been on 7-year finals while demand for Freddie K’s has been on the 4- to 7-year part of the curve.  There has also been some renewed interest in Freddie K floaters, as spreads have widened over the past few months and have now reached levels that were last seen back in mid-November 2017.

Mortgage Rates and Refinance Activity

• Benchmark mortgage rates were stable for the week ending 8/24.
  • 15-year mortgage rates declined 1bp to 3.78%, 27bps above the 12-month average of 3.51%, and 4bps above the YTD average of 3.74%.
  • 30-year mortgage rates remained at 4.40%, 25bps above the 12-month average of 4.15%, and 8bps above the YTD average.
  • 15-year mortgage rates have increased 58bps in 2018, while 30-year mortgage rates are up 55bps YTD.

Housing:

Mortgage Applications Show Decent Results, for a Change: Mortgage applications for the week ending August 17 rose 4.2%, the best week since mid-June for applications.  Purchase applications rose 2.9%, which was not quite enough to keep the 4-week average from sliding another 1.4%.  The 4-week average is now down 10.8% from its peak in May and is at its lowest level since November 2017.  Rising mortgage rates are adding to the affordability challenges in housing.   Refinance apps rose a more impressive 6.0% as 30-year jumbo rates dropped from 4.73% to 4.68% and 15-year mortgage rates fell from 4.27% to 4.25%.  Conventional 30-year rates held steady at 4.81%, remaining near their May peak of 4.86%.

FHFA Home Prices Show Still-Solid Gains, but a Slowing Rate: The June FHFA Home Price Index disappointed expectations by rising just 0.2% MoM; however, May’s tally was revised higher from +0.2% MoM to +0.4%.  After hitting a year-over-year growth rate of 7.6% back in February, home price gains are now down to their slowest rate of gain in 18 months at 6.5% YoY.  While this remains a positive rate of growth, the trend is certainly weaker.  Price gains have slowed over the past year on the East Coast, the West Coast, and in the Central Midwestern states.

Existing Home Sales Disappoint Again: The sale of existing homes fell 0.7% in July, disappointing expectations for a 0.4% increase.  This marks the fourth consecutive monthly decline with existing sales now down 4.6% since March, and further to fall if mortgage applications are any indicator.  Moreover, according to Freddie Mac’s Mortgage Market Survey, the average 30-year mortgage rate currently available is up to 4.53%.  In comparison, the BEA reports that the average homeowner mortgage rate remains at 3.76%.  As such, the average homeowner’s mortgage is now 77 bps cheap to a new mortgage, reducing the economic incentive to move.  As this differential has grown, it has continued to add pressure to a housing market already struggling with affordability challenges.

New Home Sales Join the Housing-Disappointment Party: July’s New Home Sales report added to the string of disappointing housing reports, falling 1.7% and missing expectations by almost 3%.  Sales fell to their lowest level since October which helped push supply to 309k (5.9 months), its highest level in a year.  While the report was disappointing, it was negatively affected by weakness in the Northeast that was amplified by seasonal adjustments and annualization of the data.  On a seasonally adjusted basis, sales in the Northeast fell 52% and 3% in the South. The not-seasonally adjusted, un-annualized data shows sales in the Northeast declined from 4k to 2k and in the South from 33k to 30k.  It is not uncommon for the data to be revised 1k higher or lower in each region, which could then be exaggerated higher from the seasonal adjustment and annualization.   As such, we are hesitant to make too much of any one housing report.  However, the trends remain discouraging for home sales as discussed in yesterday’s Market Today regarding Wednesday’s Existing Home Sales disappointment.  We continue to see rising mortgage rates as a material challenge to housing traction.

Michael S. Erhardt, CPA

Senior Vice President

Investment Strategist

Vining Sparks, IBG