March 18, 2019
Yield spreads on current coupon MBS to Treasuries grinded tighter last week with 15-year tightening 4 bps to 47 bps, while 30-year tightened 2 bps to 72 bps. Despite the modest level of tightening, 30-year mortgage spreads are above their 1, 3, and 5-year averages. This level of relative value hasn’t gone unnoticed as investors have been very active in the 30-year sector. The following represents a summary of the activity we’ve seen in recent weeks:
- Current production 4.0’s and 4.5’s continue to be one of the most prominent trades in the 15-year sector. Premium reluctant buyers have steered towards 3.0’s or 3.5’s.
- Lower coupon pools such as 15-year 2.0’s and 2.5’s have also been in demand and are generally being traded at a discount. These seasoned pools tend to have less negative convexity and exhibit better projected performance in a declining rate environment versus higher coupons.
- We’ve seen buying in seasoned and new production pools. Seasoned 2.5’s and 3.0’s at a discount tend to attract investors seeking potential appreciation with declining rates. Yield buyers have focused more on newer issue pools with less in projected near-term cash flow.
- Activity has picked up within this space over the past several months as depositories have focused on adding duration. Tax reform and basis tightening in Municipals has also led some investors to consider longer term MBS. A recent Strategic Insight on this topic can be found here.
- An active trade for investors seeking potentially higher yields and relatively low price volatility has been in current production GN II 5.0’s and 5.5’s, trading in the $104-$106 range. Although this is new production 30-year paper, the projected price volatility is relatively low (ranging from -11.0% to -13.0% with rates up 300 bps), primarily because of the higher coupons and prepayment patterns typically associated with FHA/VA borrowers.
- Other trades included several custom GNMA pools designed to help depositories meet their Community Reinvestment Act (CRA) goals for 2019, and buying new production relocation pools (FN 3.0’s) that are also assumed to have higher turnover than traditional mortgages.
- The focus for CMBS (Fannie DUS & Freddie K’s) has generally been on discounted pools with finals in the 7-year range. This has been a prevalent trade for investors seeking locked-out cash flow, positive convexity, and higher yields.
- There has also been solid demand for floating rate structures (Freddie K’s and FN ACES in which the fixed-rate cash flow has been swapped out for floating-rate cash flow). A prevalent trade that has occurred during the last few weeks was a new issue FN ACE 11-year final trading at a discount, offering a yield of approximately 3.00%.
Mortgage Rates and Refinance Activity
Benchmark mortgage rates were stable to lower last week. 15-year mortgage rates decreased 9 bps to 3.58%, while 30-year mortgage rates held stable at 4.31%, remaining near the lowest level in a year.
Total mortgage applications rose 2.3% last week after cooling 2.5% in the week before. The weekly gain was driven entirely by a 4.3% in new purchase inquiries as refinancing applications were mostly unchanged, down just 0.2% from the prior week. The four week average for both purchases and refinancings both edged higher during the week.
January’s New Home Sales Report Weak, But Unconvincing: New homes sales disappointed expectations in January, declining 6.9% from December’s pace to an annualized pace of 607k. On a positive note, the November and December data were revised 4.8% and 5.0% higher, respectively. As such, January’s drop was from a notably better level. Moreover, sales in the South were exceptionally weak, falling 61k (annualized). Included in the Census Bureau’s South region are Virginia, Maryland, and the District of Columbia. The government shutdown in January likely weighed on activity in those regions. As such, the disappointing January report is likely to prove temporary. Additionally, even with January’s drop, new home sales have convincingly rebounded since troughing at an annualized pace of 552k in October. Mortgage rates peaked at 4.94% (30-year fixed) and have since declined to 4.31% (Freddie Mac Mortgage market Survey). In fact, the West – the most rate-sensitive region and a region less likely to have been affected by the shutdown – saw a 40k (28%) increase in sales in January.
Construction Spending Beat Estimates But Housing Remained a Drag: Construction spending was stronger than expected in January, but there was a large negative revision to prior activity and housing remained soft. Overall construction spending rose 1.3% to start 2019, easily beating expectations for a 0.5% gain, but wholly driven by activity outside of the housing sector. Non-residential spending rose 2.4% on the back of a 0.8% improvement in the private sector and a 4.9% surge in public spending, the largest public-sector gain since 2004. Private residential spending, which accounts for nearly all of total residential activity, declined again marking a sixth consecutive month of slower spending and the fewest total dollars spent since January 2017. Within the residential categories, multi-family spending rose 1.4%, single family activity slipped 0.7%, and home improvement dollars declined 0.3%. Negative prior revisions could weigh on 4Q growth estimates but, combined with better-than-expected business equipment activity data earlier in the day, the improvement in non-residential construction will add to optimism that business investment stabilized to start the year. The residential weakness, however, shows the housing sector continues to face an uphill battle despite a boost from lower mortgage rates.
Michael S. Erhardt, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP