FRM Update

December 10, 2018



The risk-off sentiment expanded across most markets last week and mortgages were no exception to the selling. Yield spreads on current production coupons underperformed Treasuries by 1 to 2 ticks.  However, this was a fairly modest move given the strong bond market rally and selling observed in other fixed-income sectors.

The 2018 basis widening in the MBS market combined with higher Treasury yields has resulted in more attractive valuations, a reduction in extension risk, and prepayment convexity at multi-year lows.  Most investors have targeted low duration pools with lower coupons in recent months, but during the past few weeks we’ve seen buying shift away from the 15-year sector and into the 30-year sector.  In fact, we saw twice the trading volume in 30-year paper vs 15-year last week; although a healthy portion of the 30-year additions consisted of seasoned product and several trades were in pools backed by jumbo loans.

In terms of activity last week, there was good two-way flow (investors selling and buying).  We believe the selling has been spurred on by the bond market rally and investors preparing their balance sheets for year-end and positioning their portfolios for improved performance.  Given that some institutions are ahead of their 2018 budget and the fact many portfolios contain securities with book yields below current market yields, attention has shifted to portfolio restructure transactions that have the potential to boost 2019 income.  Activity has accelerated in recent weeks, likely because year-end is quickly approaching and institutions are now able to forecast estimated 2018 earnings with a larger degree of certainty.

November fixed-rate prepayment speeds decreased between 8% and 14% for all three of the Agencies.  This reverses the uptick seen in October that was more-or-less an outlier due to the extra couple of business days in the month.  At this point, to see any meaningful move in prepayment rates would seem to take a fairly meaningful decline in mortgage rates and/or changes in economic conditions.  Please see here for the complete November MBS Prepayment Commentary.

The following represents a summary of the activity last week:




Mortgage Rates and Refinance Activity



Housing:

Mortgage Applications a Positive Surprise for a Change: Mortgage applications for the week ending November 30 rose 2.0% on a 0.8% increase in purchase apps and a 6.2% increase in refi apps.  Purchase apps are now up 13.2% over the last three weeks, the strongest three-week gain since January. While overall applications remain low, the recent uptick has been a welcome surprise for one of the worst-performing sectors in the economy.

Weaker-than-Expected Construction Spending: Construction spending was disappointing with the Census Bureau reporting an unexpected decline for October and making negative revisions to activity in both August (from +0.8% to -0.4%) and September (from 0.0% to -0.1%). Activity dipped 0.1% in October instead of realizing the 0.4% bump economists had expected. Softness in the residential category was no surprise, considering the weakness in the other housing reports of late, and combined with weaker nonresidential spending to offset a recovery in spending on public construction projects. The negative revisions to the final two months of last quarter should affect 3Q GDP in its next revision and the miss for October is likely to weigh some on current quarter estimates. From a broader perspective, the persistent decline in private housing activity is evident in the YoY rate while the trend in the other two categories remains more constructive.



Michael S. Erhardt, CPA

Senior Vice President, Investment Strategies

Vining Sparks IBG, LP

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