In addition to raising the overnight Fed funds rate, the Fed is exiting the MBS and security purchase space as it wraps up QE4. The Fed will reduce its asset holdings by not reinvesting the funds received from maturing securities into new securities as it has been doing over the past two years. The MCT Review this week examines the Fed’s plans and the ultimate impact on a volatile bond market.
This week’s commentary discusses market preparation and reaction to Fed Chairman Powell’s speech in Jackson Hole. As the Fed puts the brakes on the economy, the central bank is willing to let unemployment go up as a trade for getting inflation under control. Rate hikes are expected to continue as the Fed prioritizes driving down inflation rather than economic growth. Read the rest of this week’s market commentary for more information on the Fed and the MBS market.
Every week the mortgage industry has new headlines. This week saw talk of Wells Fargo scaling back its mortgage division (possibly greatly exaggerated), MBA mortgage applications dropping to a 22-year low, and U.S. retail sales resiliently remaining flat despite a drop in gasoline prices, though the biggest story was Ginnie Mae and FHFA releasing jointly updated seller/servicer requirements.
Last week’s U.S. employment figures pointed to a continued strengthening job market while this week saw a spate of softer-than-expected inflation data, but the 10-year Treasury yield closed each week at the same level. Mortgage rates, however, whipsawed around by 0.25-0.375 percent over the last several trading days, exemplifying the basis risk of hedging a pipeline with U.S. Treasuries.
The non-farm payrolls figure came in at 528k for July, well above the survey estimate of 250k. The market has sold off and a 75 BPS Fed hike in September is more likely than 50 BPS. The strong data likely signals the end of falling mortgage rates as the Fed will keep pressing with big hikes.
We saw a noticeable drop off in day-over-day TBA hedge supply after GDP data hit the tape. TBA markets hit recent highs this week, but volatility has not subsited. UMBS has been trading in a wide range as the market is still attempting to make sense of the recent data and overall direction of the market. So much for the dog days of summer.
PMI was much weaker than expected with services dropping the most while manufacturing held relatively steady as private sector output contracted for the first time in over two years amid muted client demand. The downturn in output signaled a further loss of momentum across the economy of a degree not seen outside of COVID-19 lockdowns since 2009. The recession talks will be a major focus now.
The steady, but lighter TBA supply continued with pricing trending lower, gaining back some ground. Fed comments have helped the short end of the curve recover significantly, and better rate sheets should start hitting the screens. Ginnie Mae issuance remains at a better pace, but the late May/early June sell-off that produced a lock flush is adding to more production. Agency production, especially Ginnie Mae, shouldn’t drop off as much as the general population.
We saw steady TBA hedge volumes throughout the week with the heavy day on Wednesday. Purchase activity remains busy and some refinance activity is still present in the wake of the move lower. FNCL 5.0s have been in a tight range and reprices have dropped off. Payroll data has caused more volume to hit the market, but also more servicing selling as lenders adjust their hedges with a move into higher rates.
Steady day-over-day TBA hedge flows have included a lot of pair offs as lenders lifted their hedges with the commitment of month-end whole loan sales. FNCL 5.0s have exhibited price appreciation, gaining versus previous closing levels. TBA markets moving higher has driven rate sheet improvement and TBA hedge flows will be much lighter due to the Independence Day holiday. Ginnie Mae issuance for June has closed and reflected slight month-over-month drop.
Hedge supply has settled a bit after price movement was relatively contained with FNCL 5.0s moving within a tight range. Less intraday reprices are occuring and steady supply should continue. Be aware of pool submission cutoffs. Ginnie Mae issuance is pretty much closed for the month and it looks like we’ll end lighter versus May, though there will be some that residual will trickle in from custom issuance.
We have seen steady day-over-day TBA hedge supply, but some volatility after the ECB announcement. There have been intraday reprices throughout the week as mortgages moved wider and tighter. Rolls closed lower with lighter bank flows not enough to offset real money selling. Spec origination has been busy, highlighted by Class B and G2 custom lists. 15-year pools traded just a touch behind last month’s levels, performing better than 30-years, as investors remain focused on shorter paper. Customer interest is muted ahead of the FOMC next week. Custom pools traded fairly well, mostly holding up to recent clearing levels.
MBS have moved tighter in the face of higher volatility, as well as a pickup in demand. The basis is also tighter across the stack with 3.5s best. Spec pool origination volume has been very strong, with more cash window and bank serviced Class A pools trading. Trading levels remain elevated at significantly better levels than last month, better by a couple ticks across the board. Custom pool loan balance 4s are starting to lag a bit compared to 4.5s and 5s.
We’ve seen a slight uptick in TBA hedge supply as originators continue to hedge their pipelines before the upcoming long holiday weekend. Price appreciation triggered a bevy of reports of positive reprices and TBA supply activity should continue before quieting down. Better buyers of 4/4.5s helped ratchet mortgages tighter and ultimately ~1-2 ticks wider vs hedges. Banks flows remain muted and focused on shorter duration. Pools traded well as origination trading levels continue to push higher, aided by a sharp rally. Even with clearing levels several ticks higher than they were a week ago, spec valuations remain attractive and customer demand has been strong.
FNCL 4.5s are up versus earlier lows and we’ve seen steady but lighter volumes in the TBA space coming off a big pickup. We’ve also seen TBA appreciation as the bond market rallied, easing some urgency to lock loans. GNMA issuance is expected to end lighter versus April, but the gap appears to be narrowing. The MIP loan package cutoff for the month is coming, though we should be pretty close to that $48 billion figure in April.
Origination volume has been just short of Fed purchases, and the Fed’s biggest purchases are in 4s. The Fed plans to conduct approximately $16 billion in its reinvestment purchase operations over the next two weeks. Secondary selling has come from a mix of MMs and HFs. Notable BWICs include more than $69 million FN/FR 30yr Semi-Seas Investor 2.5s, more than $17 million G230 Seas Mixed Spec 4.5/5.0, and more than $9 million G230 MJM 2.0-4.0.
30-year coupons have seen every coupon but the 1.5% exhibit a speed decrease, with the 3.5% and 4% dropping by a quarter percent. Only the 2% through 4% coupons have outstanding float above $100 billion. The 1.5% through 2.5% coupons are all paying less than 10 CPR, the 4% through 5% are paying faster than 20. With the current 30-year conforming fixed rate at 5.53% as of Thursday’s close, UMBS 30-years have no refinance incentive.
This week saw an uptick in TBA hedge volumes and better pricing. Given that FNCL 4.0s have traded in a narrow range and rate sheets have been going out at morning highs, there have been fewer reports of negative reprices to low levels than in previous weeks. The Ginnie Mae spec pool issuance number has increased just a little bit due to customs flowing through the systems, exceeding the March totals.
We’ve seen lighter TBA supply as the market sells off into higher rates. We’ve seen reprices with the Fed all but confirming the 50 basis points hike for May. Performance on the stack has been materially weaker and coupons have been framed wider, 4.5s and 5s best. 15-years are outperformed 30-years by 2-3 ticks with steady bank buying of the sector. In major pools, 20-years are mostly higher across the board while jumbos were better than the widest levels seen a week or so ago but well below prints from last month.
MBS spreads continue to widen, along with bid-ask spreads in the TBA market. This has made the TBA market more illiquid than usual, which is having an impact on front-end rate sheets. Bid-ask spreads have increased from about 1 tick to 10 ticks, an increase of nearly 30 basis points.
The March FOMC Minutes showed that “many” officials held the view that one or more 50-basis point rate hikes could be warranted. Money market traders are betting on a further 225-basis points of increases this year. The MBS basis ended the week wider with treasuries bear-steepening, amid fresh yield highs across the curve, with 2s/10s accounting for most of the curve steepening.
We’ve seen some price appreciation and a pickup in TBA hedge supply, as well as some reprices for the better start coming through. The issuance number from customs has been bumped up, making the drop month-over-month just over $1.5 billion. Going forward we will likely see a drop of ~1-2 billion per month then a heavier drop as the more recent rate move gets digested through pipelines.
This week was all about a sell-off in the bond market. Let’s look at why that occurred, how the Fed can take action from here, and ways for those in the mortgage space to mitigate risk.
March issuance continues to pace ~1.5 billion behind the pace of February. Intermediate Treasury yields lagged both the short and long end of the curve. The reshuffling of the curve left several spreads inverted.