July 23, 2018
MBS outperformed Treasuries in a meaningful way this past week, reflecting range-bound interest rates and a steady decline in implied volatility. 15-year MBS spreads to Treasuries tightened 3 to 4 ticks, while 30-year MBS spreads moved tighter by 2 to 3 ticks. In fact, MBS spreads tightened in four of the past five trading days. After reaching the widest levels YTD (77bps) near the end of June, 30-year MBS spreads tightened to about 72bps currently.
The marginal outperformance by 15-year MBS vs 30-year MBS can be attributed to the first weekly 2s/10s steepening since May 18, when the 10-year Treasury reached 3.126%, its highest yield since 2011. The spread between 2s/10s opened at 25bps and closed 4bps higher at 29bps.
The average rates on 30-year fixed and 15-year fixed mortgages remained relatively stable during the past week. Weekly mortgage applications decreased 2.5% from one week earlier, but loan applications to refinance existing homes rebounded from their lowest levels in over 17 years. The refinance index improved 2.2% to 979.6 from one week earlier.
Housing starts slumped sharply in June (-12.3%) on weakness in both multi-family (-19.8%) and single family (-9.1%) activity. Housing permits also slipped, down 2.2% from May; while these data series are prone to volatility, June’s results were notably disappointing.
Activity was steady last week with investors focused on the following:
- Seasoned 15-year 2.5s – The cheapening trend in this coupon along with the flattening yield curve has resulted in 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 the latest Strategic Insight discussing the current merits of slightly seasoned, below par 15-year MBS.
- Seasoned 15-year 3.0s – Focused on 160-165 WAM pools. Pricing remains near par, a level last observed in mid-2011.
- 15-Year 3.5s – Newer production pools
- Seasoned 20-Year 3.0s – Several trades occurred with investors targeting seasoned pools (180-200 WAM). These structures generally have slightly lower yields than similar coupon 30-year MBS, but better OAS and convexity profiles.
Mortgage Rates and Refinance Activity
- Mortgage rates remained relatively stable for the week ending 7/20.
- 15-year mortgage rates declined 1bp to 3.79%, 36bps above the 12-month average of 3.43%, and 8bps above the YTD average of 3.71%.
- 30-year mortgage rates remained at 4.37%, 28bps above the 12-month average of 4.09%, and 7bps above the YTD average.
- 15-year mortgage rates have increased 59bps in 2018, while 30-year mortgage rates are up 52bps YTD.
Mortgage Applications: Mortgage applications fell 2.5%, seasonally adjusted, for the week ending 7/13. Refinancing made a modest comeback after retreating for the previous three weeks, as the Refinance Index increased 2.2% from the previous week. 36.5% of the applications received were for refinancing, compared to 34.8% the prior week. Housing inventory remains significantly lower than a year ago, while interest rates are higher and home prices continue to rise at more than income growth.
Unusually Weak Report on Housing Construction: Housing starts fell 12.3% in June, a very disappointing report. Starts were expected to fall 2.2% after a 4.8% increase in May. The decline was driven by a 19.8% drop in the volatile multi-family category. However, single family starts also fell an unusually large 9.1%. The declines brought the YoY rate down to -14.5% for multi-family activity and +0.0% for single family starts. The weakness was fairly broad-spread with starts in the Midwest falling 35.8%, falling 9.1% in the South, down 6.8% in the Northeast, and off 3.0% in the West. Building permits, the state prior to actual starts, were also weaker-than-expected. Permits fell 2.2% MoM (exp. +2.2%), which was driven by a 12.5% decline in multi-family permits and a 0.6% drop in single-family.
Home Builder Confidence Holds in July: The NAHB’s Housing Market Index showed home builder confidence was unchanged in July. At 68, the headline index matched its lowest level of 2018 but equaled the average reading since the beginning of 2017. The index tracking current sales was flat with June and matched its lowest level since September. There were offsetting moves in the other two major indexes. The future sales index slipped to match its weakest reading since November 2016, while foot traffic from prospective buyer perked up to its best level since February. The NAHB’s chief economists said “Builders are encouraged by growing housing demand, but they continue to be burdened by rising construction material costs.”
Michael S. Erhardt, CPA
Senior Vice President
Vining Sparks, IBG