“Too Far, Too Fast”
The market reaction went a little “too far, too fast” in regard to the Fed policy pivot. We witnessed the coupon stack (i.e., the price spread between TBA coupons) decompress in more than a trivial manner in a short period. However, the primary mortgage market has been largely reluctant to follow the Treasury rally, and mortgage rates have ultimately not dropped by the same amount as Treasury yields.
Mortgage traders over the past month have priced prepayment speeds too fast, with curve-implied durations too short. That was evident in the stack compression and coupon swaps trading “fast.” In practice, S-curves aren’t that sensitive. Even with the basis all over the place, pipeline hedgers still have to manage that movement when adding or lifting coverage.
If you haven’t already, we recommend reading our latest blog, March Housing Market Update: After Silicon Valley Bank Collapse, which details recent changes to the composition of bank portfolios and how we got to this point. Silicon Valley Bank’s cardinal sin was to buy Treasuries and MBS without hedging the interest rate risk. When the bank was met with a deluge of withdrawal requests, it sold its available-for-sale securities at a loss in the hope it would cover withdrawals.
The money supply continues to drop, forcing mortgage spreads wider, volatility higher, and agency MBS issuance down. Rates are not set by the Treasury market, but rather the TBA market where capital markets folks can sell their loans. Even though the MBS basis has been driven wider by interest rate volatility, currently sitting near 300 bps versus the five-year average of slightly more than 210 bps, the primary/secondary spread is right around its trailing five-year average of roughly 110 bps.
The Fed’s tightening policy still has had little to no effect on the labor market.
Peak Fed Funds Rate = Normalcy?
Today, inflated prices, high interest rates, and few active listings continue to make both finding and buying a house extremely difficult, and refinance appetite non-existent. While the current environment is not primed to change anytime soon, the peak of the Fed’s tightening cycle should help markets to price in lower yields and steeper curves. The trouble for the Fed is that there are excellent reasons for it to continue raising interest rates and excellent reasons for it to take a break. The fed funds futures now see a coin flip for another 25 bps hike in either May or June to get to a Fed funds rate of 5%, and then they see the Fed beginning to cut rates.
It was wonderful seeing everyone in San Diego last week for this year’s MCT Exchange! For those that attended, we hope you enjoyed the general sessions, a keynote from Fannie Mae’s Doug Duncan, as well as the roundtables and breakout sessions! Get a full snapshot of the event by reading through our recap post, viewing the slide decks of each session, and checking out the event photo gallery. You can find market forecasts from Fannie Mae Chief Economist Doug Duncan, the latest on MCT’s vision for the secondary market, and valuable strategies from lenders and experts.