October 9, 2018
The sell-off in the bond market caused yield spreads between current production coupon and Treasuries to widen 5bps for 15-year MBS and 8bps on 30-year MBS. The improvement in the steepness of the yield curve helped 15-year MBS modestly outperform 30-year MBS. Yield spreads on 15-year MBS are now at the top end of their YTD range, while spreads on 30-year MBS have set YTD highs.
Trading activity was steady, despite the market volatility, as investors took advantage of lower dollar prices and higher yields. There was a renewed interest in 15-year 2.0s trading at a deep discount. These structures are projected to perform well in rising rate scenarios with limited extension risk and stable cash flows.
September prepayment speeds were released last week. There were sizable slowdowns across all coupons, reflecting the combined effects of rising mortgage rates and burnout across the portion of the mortgage population still above market rates and also some important seasonal and technical factors. Please see the complete prepay commentary here.
The following represents a summary of the activity last week and themes in the overall sector:
- 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.
- 15-Year 4.0s and 4.5s – 15-Year 4.0s are trading at relatively low premiums (~$102) and offer a projected yield spread to Treasuries of approximately 50bps.
- 20-Year 3.0s and 3.5s – Pay ups in this sector have recovered from their lows in early September, with solid demand from investors.
- Seasoned 20-Year 3.0s and 4.0s – Seasoned pools with WAMs ranging from 180-200, an alternative to new issue 15-year MBS with higher premiums.
- FNMA DUS and Freddie K’s – The focus for FNMA DUS has been on 7-year finals while demand for Freddie K’s has been on the 3- to 5-year part of the curve.
Mortgage Rates and Refinance Activity
- Benchmark mortgage rates moved higher on the week (10/05).
- 15-year mortgage rates increased 10bps to 4.03%, 42bps above the 12-month average of 3.61%, and 27bps above the YTD average of 3.76%.
- 30-year mortgage rates increased 18bps to 4.75%, 51bps above the 12-month average of 4.24%, and 39bps above the YTD average of 4.36%.
- 15-year mortgage rates have increased 83bps in 2018, while 30-year mortgage rates are up 90bps YTD.
Weak Residential Construction Weighs on August’s Construction Spending: August’s Construction Spending report disappointed expectations, with spending rising just 0.08% MoM on weak residential and private facilities activity. Residential construction, making up 42% of total construction activity, dropped 0.8% on declines in every category: single family construction down 0.7%, multi-family construction down 1.7%, and home improvement down 0.6%. The year-over-year growth of residential construction is now down to +4.1% from a cycle high of +23.8% in early-2013. On a quarterly basis, the 3Q data now points to a 5% decline in 3Q for residential construction Private non-residential construction was weighed down by declines in commercial construction, power plants, and manufacturing facilities; now pointing to a 1% decline in non-residential structures investment in 3Q. Public construction, making up 24% of activity, was the lone bright spot in the August report. Up 2.0% MoM, public construction activity is now up 14.0% YoY, an increase from -7.4% YoY in early-2017. Construction of highways/streets, sewage/waste, and water supply facilities continued to drive activity higher. Despite August’s disappointing report, construction spending continues to be led higher by private facilities investment and public spending; housing construction continues to raise concerns.
Michael S. Erhardt, CPA
Senior Vice President
Vining Sparks, IBG