MBS Issuance Down
This week marks the last week before the arrival of the year-end holiday season, when Thanksgiving, Christmas, and New Year’s Eve all work in tandem to boost vacation days and reduce trade volume. As we enter the holiday season, everyone in the mortgage industry has the same problems: lower volume, lower pricing and gain on sale margins. With less emphasis on growing volume, due to a lack of borrower demand from currently high mortgage rates and a lack of seller demand from being locked into low mortgage rates, a much greater focus for companies in the mortgage industry has been on lowering costs and increasing profitability.
Gross issuance of all agency mortgage bonds has declined for eight straight months to now sit at its lowest level since April 2019, below $100 billion a month and about 1/3 of what we were experiencing at this point last year. That trend likely won’t change going into the new year, as December, especially its latter half, sports the lowest average daily trade volume for any period of the year. Agency mortgage bond gross issuance forecasts have been reduced to end 2022 at around $1.8 trillion, far below the $3.3 trillion average seen in 2020 and 2021, though better than the $1.3 trillion annual average seen during the 2000 through 2019 period.
As has been noted, those lower volumes mean that the Federal Reserve is winding down QE4 at an opportune time. Unfortunately, the QE4 spigot that pumped $3.1 trillion of credit to the mortgage sector makes it likely that it will take years of new mortgage lending to reset the universe’s weighted-average coupon higher before the refinance industry returns to normal. To give you an idea, raising the percentage of homeowners with refi incentive to a historically reasonable 20% of the UMBS 30-year universe would require the 30-year rate to drop down to 3.50%. Thinking more realistically, a sub-6% mortgage rate that won’t move the needle on the refi market, will do a lot on the affordability front. We’re getting toward the point where people will remember rates above 7% and will now think a rate with a 5% handle is low.
The Fed and Inflation
Speaking of the Fed, recent rate movement and volatility has been driven by the debate over how long the central bank will extend its campaign to curb elevated inflation. A lot has been made of the word “pivot” from a monetary policy perspective (e.g., “How long until the Fed pivots?”). Pivot means all the following, in order: slow the pace of rate hikes, pause hikes, and cut rates. The talk of a pivot has arisen because there is some evidence that we’re moving past peak inflation, and we have likely seen the end of 75 BPS increases in the fed funds rate following FOMC meetings.
We learned last week that U.S. inflation (as well as the core measure that excludes food and energy) fell in October by more than forecast, perhaps giving the Fed room to maneuver as it considers smaller interest-rate hikes. The Fed will get one more inflation reading on its favored inflation gauge, the Core PCE index, prior to its December meeting. Keep in mind, during the 1979-1982 period when Fed Chair Volcker was fighting severe inflation, the fed funds lower bound averaged more than 3.5% above the CPI annualized rate. Currently, the fed funds lower bound is almost 5% below the CPI run rate. Stats like this give credence to the idea that the market might be a bit too excited and remind us that there is a way to go in the fight against inflation.
The volatility seen in mortgage rates this year should subside once 1) the peak rate for this hiking cycle comes into view, and 2) inflation begins to slow.
We are at or close to the neutral rate, meaning the policy rate that neither stimulates nor restrains economic activity. Determining that rate can accurately be described as an educated guess, which Former Fed Chair Ben Bernanke’s highlighted as a shortcoming in the foundation of modern central banking as practiced in America. Bernanke opined that both the natural policy rate and natural rate of unemployment are pure guesswork. That makes it hard to set monetary policy for an entire nation, and in some ways, the globe.
Concerns and Recommendations
Eventually things will return to normal. The question is when. These are certainly different times from the financial crisis (back then, the issue was largely loan repurchases on Alt-A and subprime loans), now there aren’t even any loans to argue over. A 10-year Treasury paying below the rate of inflation isn’t an attractive investment. Pipeline hedgers beware. Though the market has forced higher coupons into liquidity, not many coupons are trading above par after recent sell off, and this will take time to normalize. Liquidity in the 6 and 6.5 remains limited, with wide bid-offer spreads.
We’re here to help you improve profitability. Continue to monitor coupon liquidity and maintain a dynamic hedge strategy. Trade as production comes in, staying consistent will protect margin. Match market levels of hedge positions to front end locks. Ensure secondary policies and procedures are buttoned up and being executed from lock desk to loan delivery. For agency-approved sellers delivering a portion of production to the agencies on a retained basis, engage in Agency Cash. Take advantage of Assignment of Trade (AOT), which can provide critical cash flow benefits during market sell offs and save you currently wide bid-offer spreads (e.g., A 4-tick savings on a $1 million AOT saves $1,250), especially on less liquid coupons. Trade to production and expected expiration for AOT possibilities and utilize investor AOT programs that allow for assignment of non-production coupons. Finally, seek diverse execution outlets. The average MCT client has 21 aggregator approvals. BAM Marketplace can be used to test and commit with unapproved investors – opt in if you haven’t already.