Treasury rates plunged last week after the announcement of a cut in the Fed Funds target rate on Wednesday was followed by an escalation of the trade fight between the U.S. and China. While the entire Treasury curve rallied, intermediate and long Treasuries had the best performance, with yields dropping between 19 and 22.5 basis points week/week. The rally left the 2-10 year spread at +13.4, its tightest level since last December, while the 2-5 year spread inverted again and closed the week at around -5.5 bps. Money market rates were mixed, however, as 1-month LIBOR was virtually unchanged while SOFR (a market-based overnight rate) went from 2.41% on 7/26 to a high of 2.55% on July 31st (possibly distorted by month-end pressures) to end up at 2.19% on Friday. Overseas rates also plunged, leaving the entire German sovereign curve (including their 30-year bond) at negative yields.
*The MBS Weekly Market Profile Report corresponds to the commentary below.*
Pegging the performance of mortgages and MBS in this type of market is difficult, since some of the most commonly used measures are distorted. On a duration-neutral basis, liquid Fannie coupons lagged the 10-year note by 9-12 ticks, while Ginnies trailed the 10-year by almost a half point on the week. While MBS durations shortened sharply after the rally, the fact that Fannie 3s closed 1/32 lower on Friday (versus a 14/32nd gain on the 10-year) was a telling indicator of a distressed market. While the Fannie Mae current coupon spread over interpolated Treasuries ended unchanged, the current coupon rate is increasingly distorted in volatile markets such as these and doesn’t accurately reflected the (poor) performance of the sector. Keep in mind that the rate is basically interpolated from coupons above and below parity (i.e., par value adjusted for payment delay and frequency). Fannie 2.5s, which were the “discount” coupon prior to this morning, are quite illiquid—daily trading volumes in the coupon averaged $1.3 billion since July 1st versus just under $42 billion for Fannie 3s. Therefore, the sharp (18/32) shrinkage in the Fannie 3/2.5 swap reflected at least some distortions in relative value due to the sharply different liquidity for the two securities. Moreover, with Fannie 2.5s now trading at 100-05 at this writing the current coupon rate will now have to be extrapolated, which makes it highly questionable as an indicator. A better performance gauge in markets such as these is the spread of the primary (consumer) rate over Treasuries; that spread widened by about 16 basis points last week. While that spread incorporates originator behavior as well as MBS performance, it’s arguably a better (if less precise) indicator of the product’s overall performance.
The Fed also announced a slightly early termination of the scheduled reductions in its holdings of securities. Effective August 1st, the Fed will reinvest all maturing Treasury securities into new Treasuries; it will also reinvest monthly MBS principal payments of up to $20 billion in Treasuries, with any payments in excess of the $20 billion cap being rolled over into MBS. However, the Fed’s quietly re-entered the MBS market the week ending May 22nd of this year, and since late June their weekly net purchases have averaged $682 million in Fannie and Ginnie II 3s and 3.5s. While the MBS to be purchased will probably remain relatively small (due to the impact of the $20 billion cap), it will be interesting to see if the Fed tries to support liquidity in the market for Fannie 2.5s. The Fed only briefly bought small amounts of 2.5s; their largest purchase of the coupon was the week of 12/19/12, when they bought $850 million while also buying $14.8 billion of conventional and Ginnie II 3s. If rates remain at current levels or decline further, Fed purchases of 2.5s would improve liquidity for the coupon while also helping to push consumer mortgage rates lower.
About the Author: Bill Berliner
As Director of Analytics, Bill Berliner is tasked with developing new products and services, enhancing existing solutions, and helping to expand MCT’s footprint as the preeminent industry-leader in secondary marketing capabilities for lenders.
Mr. Berliner boasts more than 30 years of experience in a variety of areas within secondary marketing. He is a seasoned financial professional with extensive knowledge working with fixed income trading and structuring, research and analysis, risk management, and esoteric asset valuation.
Mr. Berliner has also written extensively on mortgages, MBS, and the capital markets. He is the co-author, with Frank Fabozzi and Anand Bhattacharya, of Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques, which was named one of the top ten finance texts in 2007 by RiskBooks. He wrote and edited chapters for The Handbook of Mortgage-Backed Securities, The Handbook of Fixed-Income Securities, Securities Finance, and The Encyclopedia of Financial Models. In addition, Mr. Berliner co-authored papers published in The Journal of Structured Finance and American Securitization. He also wrote the monthly “In My View” column for Asset Securitization Report from 2008-2012.
