Monday, August 4, 2014

FLASH UPDATE: TRV Weekly Commentary

TRV Weekly Commentary
Week Ending 29 July 2014


Comment:
The mortgage basis tightened 4 bps last week to 149 bps over the 5yr yield. The street continues to promote tactical long positions in the basis for the short term. Lower coupons continued to be the best performers this week as FNMA 3.5s were up 10 ticks vs their 5yr hedge. Despite recent performance, we are still not constructive on the basis due to lower Fed purchases and an expectation of increased supply over the next few months. We also expect lock desks to short TBAs as rates rise, which could place further pressure the basis. Our regression model suggests that the fair value spread to 5yr yields is 150 bps.  Sitting at 149 bps, 1 bps of widening to our fair value estimate translates to 2 1/8 ticks widening on production coupons. We continue to seek alternatives to the basis to provide sources of alpha.

One potential opportunity is to buy the GNMA II 3.5 Roll. We saw a relatively high prepay print last month due to servicer buyouts of GNMA collateral. The market continues to penalize the roll (currently at 7 ½ ), but we believe a long position will benefit as prepays slow.

On the prepayment front, the refi index fell 56 points this week, and the purchase index remained flat. Low prepayments and expectations of rising rates has kept IO OASs tight, and we hold this expectation going forward.

Noteworthy:
On July 24th, we saw a strong initial jobless claims print (284 vs 307k) and 10yr yields increased above 2.50.  The Fed continues to make dovish statements, but there is gathering support for the hawks.  The strong GDP print (4% annualized) on the 30th furthered this notion, as the 10yr backed up 9bp and origination hit $2.2 bln.  After a few false starts, it will be interesting to see if we reach a turning point in rates.

Regards,

Tradex Global Advisory Services, LLC
investorrelations@thetradexgroup.com 
203-863-1500
@Tradex_Global

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