Monday, April 20, 2015

FLASH UPDATE: TRV Mid-Month Commentary - When is that Rate Hike Coming?

TRV Mid-Month Commentary | April 2015


Comment:
Yields have fallen month to date with the front end of the curve leading the rally. The price action left the 10yr at 1.89% and the curve 2 bp steeper 5s/10s. The litany of poor economic releases is to blame for the rally, with Non-Farm Payrolls (NFP) being the most damaging to investors’ sentiment. Change in NFP came in at 126k versus 245k consensus, but we remind investors that the economy needs job creation at 80-90k net per month to maintain the unemployment rate. Retail sales also disappointed having come in at +0.4% versus +0.7% expectations.

While employment changes receive headline attention, the FOMC notes that energy prices, the strength of the dollar, and other factors warrant consideration prior to commencing rate normalization. The slope of the yield curve implies that investors have changed their estimated liftoff date from June to September. Although recent economic releases have been poor, some have chalked them up to be noise in an otherwise healthy economy.

April’s MBS prepayment print was much anticipated due to January’s dramatic drop in rates and the 50 bp Mortgage Insurance Premium (MIP) cut for GNMA collateral. Higher purchase seasonals and a greater March day-count further contributed to speeds. Overall, 30yr collateral increased 23% with new vintage cuspy coupons, such as 3.5s and 4.0s of 2015, notably higher having increased 39% and 119%, respectively. GNMA-I and GNMA-II voluntary prepayment speeds increased 31% and 23% respectively, largely on the 50bp MIP reduction that was announced in January.

Related to speeds, the FHFA announced that it will eliminate the adverse market charge instated in 2008 and will replace this revenue by increasing guarantee fees. For high LTV and low FICO borrowers, the LLPA charges will drop 25 bps. Since the option to refi is less callable for this subset of borrowers, we expect the overall market impact of the policy change to be minimal.

In the mortgage market, the dramatic decrease in vol and the steeper yield curve pushed MBS noticeably tighter with 3.5s outperforming the Treasury curve by 11 ticks. Benchmark IOs did not fare as well as lower rates reignite prepayment fears. IOS 4s widened between 30 and 45 bps the last two weeks while 4.5s widened closer to 60 bps. We view this temporary widening an opportunity as carry remains attractive and the fastest speed prints are likely behind us.

Noteworthy:
We see upcoming opportunities in mortgage credit markets. First, FNMA released details regarding the sale of non-performing loans to private investors. Such new deals may provide yield that investors desperately desire at discounted prices. Secondly, HPA came in +5.7% year-over-year providing relief to underwater borrowers. As curing continues, voluntary prepayments may provide future upside as most RMBS are priced below par.  Lastly, there is approximately $5.6 bln of current pay, never modified 10yr IO loans that are set to begin amortizing. As such, Alt-A deals with this collateral may provide considerable prepayment upside that we feel the market isn’t accurately pricing.

Regards,

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