June 8, 2020
Fed Intervention and Yield Spreads
Over the past eleven weeks, the Fed has purchased just over $700bn of agency MBS as part of its effort to stabilize the sector. The buying has been focused on the 30-year pools with lower coupons. To put the scale of buying into context, during the sums of QE1 in 2008/2009 and QE3 in 2012/2013, the Fed bought ~$1.4tn of mortgages; each of these episodes took over a year to complete. The Fed has gradually lowered its planned purchases since the start of QE4. The daily total of mortgage purchases has been reduced from a peak of ~$50bn/day to ~$4.5bn/day.
The historic level of Fed purchases has significantly reduced price and spread volatility in the sector. The feverish pace of the Fed support in March brought spreads from the wides that rivaled the level reached in 2008/2009. Nominal 30-year mortgage spreads to Treasurys touched a stressed level of almost 150 bps. Within a week of Fed’s intention to purchase up to $50bn per day of agency MBS, spreads came in to 75 bps.
Yield spreads were volatile last week as the Treasury market sold off in a fairly dramatic fashion as payrolls improved more quickly than investors had anticipated. Nominal spreads for production MBS to Treasurys were tighter on a week-over-week basis, with 15-year tightening 12 bps to 66 bps and 30-year narrowing 9 bps to 108 bps. Although yield spreads on production coupons were generally tighter, there was widening on higher coupons, likely in response to the May prepayment report that showed speeds were faster than expected.
Investor Trading Activity
Most financial institutions continue to be active investors as it’s become punitive to hold excess liquidity because of the paltry Fed Funds rate. There is also some concern that yield spreads may begin to tighten as supply in many sectors is challenged.
There was broad-based trading activity last week with customers generally buying securities. New purchase activity has been focused on what the Fed isn’t buying (non-deliverable MBS securities), as these products generally offer wider spreads vs TBA-eligible securities.
Last week activity included the following:
- GNMA Jumbos (MJM 2.5s to 3.0s)
- FNMA Jumbos (FNCK 2.5s to 3.0s)
- UMBS 15-year 2.0s (new production)
- UMBS 15-year 2.5s (seasoned)
- UMBS 20-year 2.0s and 2.5s (new production)
Mortgage Rates and Refinance Activity
Mortgage rates were mostly stable last week, with the 30-year holding at 3.52% and the 15-year declining 3 bps to 2.84%. Refinance activity decreased 8.6% for the week ending May 29, according to the Mortgage Bankers Association. The index has declined 8 out of the last 10 reports and has dropped 51% since hitting a YTD high on March 6. The purchase index rose 5.3%, the seventh consecutive weekly gain in applications for home purchases.
Lenders have the primary/secondary spread at 1.80%, above its trailing one-year average of 1.29%, in order to manage risk. The spread is currently at its tightest level since April 24.
The spread could begin to narrow further, as United Wholesale Mortgage (UWM), which holds nearly a third of the market share in wholesale mortgage lending, is now offering its brokers the ability to offer borrowers 30-year fixed-rate loans as low as 2.5%. This could have a meaningful impact on refinance activity if other brokers follow UWM’s lead. Investors should continue to use caution when considering higher coupons and larger premiums.
The May prepayment report saw aggregate conventional Fannie Mae 30-year speeds drop just 2% (consensus was for a drop of 10%) following faster-than-expected increases of 26% and 42% the previous two months, respectively. Ginny Mae II 30-year aggregate speeds were 3.1% higher. The refinance index has dropped eight out of the last 10 weeks, but late speeds have remained strong. Please see here for our complete prepayment commentary.
Michael S. Erhardt, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP