FRM Update

October 29, 2018

Yield spreads on current production coupons to Treasuries have widened significantly during the month of October. 30-year current coupon spreads versus the Treasury curve are approximately 85bps currently, and have widened 9bps since the end of September.  15-year MBS have experienced even more widening with yield spreads expanding 14bps over the same time period.

While most fixed-income sectors experienced some widening in last week’s market rally, the Fed reinvestments are ending this month, and the loss of a steady buyer could be impacting investor sentiment.  Although the Fed’s market support is ending, gross supply should begin to tapper into the winter months, which may help support current valuations.  Gross supply in September fell $14bn versus August, and early readings show that October figures are running ~10% below September.

We’ve seen decent activity on the MBS desk over the past two weeks, as investors have taken advantage of higher yield spreads.  Activity continues to be focused on 15- and 20-year passthroughs with relatively low coupons.  15-year 2.0s (~150 WAM) trading at a deep discount comprised the bulk of activity in the 15-year sector.  These structures are projected to perform well in rising rate scenarios with limited extension risk and stable cash flows.  They are also one of the strongest performers across the coupon stack from a LIBOR OAS perspective. Yield buyers favored new production 20-year 3.5’s at a discount.

The following represents a summary of the activity last week and themes in the overall sector:

• 10-Year 3.0’s and 3.5’s – Payups are roughly unchanged over the past two months. The strength is largely due to strong bank demand, primarily because of the defensive nature of these structures.
• Seasoned 15-year 2.0s to 3.0s – The flat yield curve and relative value in these coupons has driven investors to this segment. There continues to be 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 a recent Strategic Insight discussing the current merits of slightly seasoned, below par 15-year MBS.
• 20-Year 3.5s – New production 3.5’s trading at a discount are a relatively short-duration alternative to 15-years. We’ve also seen consistent buying of seasoned 20-year 2.5’s and 3.0’s as an alternative to higher premium 15-year product.
• 30-Year 4.0s – Some limited buying from Public Funds accounts in longer duration paper trading near par.
• FNMA DUS and Freddie K’s – The focus for FNMA DUS and Freddie K’s last week was on 3- to 5-year finals. Yield spreads on Freddie K’s have widened 3 to 4bps during the past two weeks.
• Non-TBA pools – Activity in off-the-run collateral remained steady with investors buying seasoned FNMA Relocation 30yr 3.5’s, seasoned HLTV FNMA 15-yr 2.5s, and HLTV Freddie 30-yr 4.0s.
• MBS pools – The MBS desk routinely creates custom MBS pools to assist financial institutions with the Community Reinvestment Act requirements.

Mortgage Rates and Refinance Activity

• Benchmark mortgage rates moved lower on the week (10/26).
  • 15-year mortgage rates decreased 5bps to 4.04%, 37bps above the 12-month average of 3.67%, and 26bps above the YTD average of 3.78%.
  • 30-year mortgage rates decreased 5bps to 4.70%, 41bps above the 12-month average of 4.29%, and 32bps above the YTD average of 4.38%.
  • 15-year mortgage rates have increased 84bps in 2018, while 30-year mortgage rates are up 85bps YTD.

Housing:

New Home Sales Tank on More than Just the Hurricane Impact: New home sales tanked in September, unexpectedly down 5.5%.  The drop appears to have been driven by much more than Hurricane Michael with sales down 41% in the Northeast and 12% in the West.  In the area that would have been most affected by the hurricane, the South, sales were down just 1.5%.  New home sales have now fallen 22% since November’s peak and are down 8.3% QoQ in 3Q18 – which is likely to be one of the sole sources of weakness in tomorrow’s GDP estimate.  The inventory of new homes for sale rose to 327k, meaningfully higher than the low point of 142k back in 2012.   However, when put in context of the number of households, the inventory remains at just 0.27% versus a longer-run low range near 0.28%.  Additionally, the supply/demand dynamics in the flow of new construction still remains encouraging with homebuilders not sitting on a glut of inventory.

MBA Mortgage Applications report for the week ending October 19: Applications rose 4.9% on a 2.0% increase in purchase apps and a surprising 9.7% increase in refi apps (a bounce-back from the 9.0% decline in the previous week.  The weekly noise in the data appears to have been related to Hurricane Michael making landfall on October 10 and the overall trends are unlikely to be altered.

Michael S. Erhardt, CPA

Senior Vice President

Investment Strategist

Vining Sparks, IBG