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:

Mortgage Rates and Refinance Activity


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

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