FRM Update

January 7, 2019

Despite the fact that Treasury yields moved down slightly on a week over week basis, there was considerable intraweek volatility in the bond market. Yield spreads were relatively unstable as a result. The largest moves came later in the week. On Thursday there was a significant rally in the bond market. The 2-year yield dropped 8.9 bps to 2.38% while the 5-year yield fell 10.0 bps to 2.36%, both posting their biggest daily declines since May 2018.  We believe the fear of further declines in yields caused investors to become fairly active, as MBS activity ramped up in a meaningful way on Friday. The heightened demand sent yield spreads for current production 15-year MBS to Treasuries tighter by 3bps and 2bps tighter on 30-year MBS.  The increase in demand and subsequent tightening could also reflect the fact that Agency MBS tend to be a safe haven asset class among spread products, particularly compared to corporates.

Valuations are reasonably attractive as yield spreads remain on the upper-end of the trading range over the past year.  The Spread Snapshot table below puts this into perspective when you compare yield spread levels one year ago.

The following represents a summary of the activity last week:

• 15-Year – The most active trade during the past two weeks has been in 15-year 4.0’s. The higher coupons have experienced more widening in recent weeks because of interest rates declining and premium aversion.  We have seen these pools trade at 75 to 80 bps over the Treasury curve based on consensus prepayment speeds.  Dollar prices are in the $103 range.
  • There was also continued demand for lower coupons (seasoned 2.0’s and 2.5’s) for investors targeting less negative convexity and better performance in declining rate environments.
• 30-Year – This was the most active sector during the past week. Several financial institutions purchased a new single-issuer GNMA II 5.0%.  This was a pool issued by one of the originators that was recently restricted by Ginnie Mae from participating in the multi-issuer pools.  The obvious appeal of this pool is the projected yield of 3.88% and relatively short average life of 3.9 years based on consensus speeds.
  • There were also trades in new issue FN 4.0’s and 4.5’s and several purchases of both FN and GN pools (4.0’s and 4.5’s) backed by jumbo loans.

• FNMA DUS and Freddie K’s – The focus for FNMA DUS has been on 7- to 10-year finals. This has been a popular trade for investors seeking locked-out cash flows and positive convexity.
  • Yield spreads on Freddie K’s have widened over the past two months and investors are targeting 3- to 4-year finals.  There has also been demand for floating rate structures (FNMA Aces and Freddie K’s in which the fixed-rate cash flow has been swapped out for floating-rate cash flow).

Mortgage Rates and Refinance Activity

• Benchmark mortgage rates continued to decline last week (1/4).
  • 15-year mortgage rates decreased 9bps to 3.68%, the lowest level since April 2018.
  • 30-year mortgage rates decreased 11bps to 4.49%, the lowest level since September 2018.
  • 15-year mortgage rates have decreased 45bps and 30-year mortgage rates have declined 33bps since the beginning of November 2018.

Housing:

Mortgage Apps Fall in Throw-Away Week: Mortgage applications for the week ending December 28 fell 8.5% on a 7.6% drop in purchase apps and a 10.6% drop in refis. While this marks the largest weekly decline in over a year, applications can be volatile around the holiday season.  In fact, applications around the Christmas week have dropped an average of 11.6% over the last five years. Particularly given the recent drop in mortgage rates, we are remiss to make much of this report.

Michael S. Erhardt, CPA

Senior Vice President, Investment Strategies

Vining Sparks IBG, LP