February 4, 2019
Yield spreads on current production MBS to Treasuries were mixed but relatively stable for the week. The tightening of 4 to 7 ticks since year-end can be attributed to a decline in implied volatility, seasonal lows in supply, and positive sentiment following the dovish FOMC meeting. While the expected pace of rate hikes has slowed, investors also focused on the expected trajectory of the Fed’s balance sheet, which has shifted as well.
The following represents a summary of the activity last week:
- Most of the activity continues to be in current production 15-year 4.0’s. Although spreads have contracted slightly, these pools are trading at approximately 80 basis points over the Treasury curve based on consensus prepayment speeds. Premium averse buyers have generally opted for 3.5’s trading in the mid-$101 range.
- Lower coupon pools such as 15-year 2.5’s (150 WAM) have also been in demand and are generally being traded at par or less. These seasoned pools tend to have less negative convexity and exhibit better projected performance in a declining rate environment versus higher coupons.
- Other trades included 15-year 3.0’s collateralized by relocation loans. Generally, these pools tend to have prepayment speeds that are greater than the generic cohort across all interest rate scenarios.
- Activity consisted of seasoned pools (3.0’s and 3.5’s) trading at a discount. There was also demand from financial institutions adding current production 4.0’s.
- Activity has picked up within this space over the past two months as depositories have focused on adding duration in order to address down rate exposure. Tax reform and basis tightening in Municipals has also led some investors to consider longer term MBS. A recent Strategic Insighton this topic can be found here.
- Other trades included several custom GNMA pools designed to help depositories meet their Community Reinvestment Act (CRA) goals for 2019.
- Agency CMBS spreads widened towards the end of 2018, in line with the broader market. However, DUS and Freddie K spreads remained stable in January compared to tightening in Agency MBS.
- The focus for FNMA DUS has generally been longer finals (7-12 years). This has been a prevalent trade for investors seeking locked-out cash flows, positive convexity, and higher yields.
- Investors seeking Freddie K’s have been focusing on 3- to 5-year finals, which offer attractive spreads over the Treasury curve.
Mortgage Rates and Refinance Activity
- Benchmark mortgage rates decreased from the previous week.
- 15-year mortgage rates decreased 3bps to 3.71%, the lowest level in nine months
- 30-year mortgage rates decreased 14bps to 4.39%, the lowest level in five months.
Pending Home Sales Fell Unexpectedly Despite Mortgage Rates Pulling Back: Pending home sales fell unexpectedly in December, marking a third month of slowing contracts on existing home sales. Total sales fell 2.2% in December, compared with estimates for a modest 0.5% increase. Fewer contracts were signed in three of the four regions with the biggest disappointment marked by a 5.0% plunge in the South, the largest decline for the region since April 2011. There was a 1.7% uptick in contracts on homes in the West. The recent Home Builder surveys from the NAHB showed prospective buyer traffic slowed notably late in 2018 as mortgage rates climbed to a November peak. While that report is more directly tied to sales of new homes, the trend could logically be applied to the existing home sector as well. While rates fell throughout December and reached nine-month lows in recent weeks (Freddie Mac Survey rate was down from 4.94% in November to 4.45% last week), any positive effect may yet be a month or more away as potential buyers re-start their searches. For now, however, pending home sales at a near-five-year low (April 2014) point to continued weakness in existing home sales to start 2019.
New Home Sales Surged the Most Since 1992: On Wednesday, the Commerce Department published an updated release calendar for several data series it’s responsible for publishing, but which were delayed by the month-long government shutdown. The first of those reports was released yesterday (Thursday) after markets opened and showed the largest single-month gain for new home sales since January 1992. The 16.9% MoM surge pushed the annualized pace up to 657k units, the best pace in eight months. In addition to November’s positive results, each of the previous three months was revised higher for a cumulative upward revision of 44k units. At the regional level, sales in the South, which generally account for more than half of total activity, popped an impressive 20.6%. Activity in the Northeast and Midwest also reflected hearty percentage gains while sales in the West slipped to a five-month low. While November represented the peak for several separate measures of mortgage rates, buyers saw affordability improve on the pricing front. The median price tumbled to a 21-month low of $302.4k, representing an 11.9% drop from a year earlier, the biggest annual change since February 2009. While new home sales tend to be volatile, the monthly jump represented a recovery from October’s steep 8.3% decline, the fact that sales jumped as prices fell could portend a potentially more positive outlook for near-term activity, especially if the recent decline in mortgage rates holds in the months ahead.
Michael S. Erhardt, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP