The Fed

My last two posts have emphasized the critical role that the Federal Reserve's purchases of Treasuries will play, for the remainder of 2009, in both capping Treasury yields and keeping consumer mortgage rates low.  In their post-meeting statement released on Wednesday, the Fed's Open Market Committee (OMC) pointedly stated that it will "continue to evaluate the timing and overall amounts" of its longer-term Treasury purchases.  This statement was classic Fed-speak for "stay tuned," and triggered a sharp selloff in an already weak bond market.

The scale of the post-announcement downdraft did not come as a huge surprise, based on the large Treasury positions that primary dealers have been holding.  Given the enormous supply of debt being issued by the Treasury, the Fed's purchase program has been essential to holding down intermediate Treasury yields and consumer mortgage rates.

By mid-day on Friday, the 10-year Treasury note has sold off a bit more, pushing its yield to around 3.18%.  I expect the Fed to resume its purchases fairly soon, in order to try to hold the note's yield under 3.15%.  However, yields will most likely push higher if they fail to act; if they let the 10-year yield approach 3.25%, I don't expect the market to stabilize until it breaches 3.50%.  It would be completely illogical for them to fail to act at this point, as it would undo the benefits of their previous purchases; however, the lack of precedent for this activity suggests a wary stance.

Jumbo Mortgage Market

The spread between jumbo- and conforming-balance fixed rates has closed a bit, but it remains stubbornly wide at around 150 basis points.  The tightening of these spreads in March resulted from a push into this sector by a number of large lenders.  However, I can't envision this spread tightening further unless the non-agency MBS market returns to some degree of normal functioning.  The problem is that non-agency (or "private-label") MBS continue to trade at levels that make securitization uneconomical.  The lack of a viable capital markets outlet for production means that lenders writing fixed-rate jumbo loans are, I believe, forced to hold them in portfolio.  Depositories typically don't like to hold fixed-rate loans on their books, since it increases their exposure to the yield curve; in the current environment, regulators also don't like depositories to hold loans in portfolio.

This puts lenders in a conundrum.  While they'd like to make more jumbo loans, they have limits on what they can hold in portfolio, which forces them to price them unattractively (or, in many cases, build a cushion into the rate).  On the other hand, capital market execution translates into rates easily in excess of 10%.  Until the private-label market returns to something approaching its earlier functioning or an alternative securitization vehicle develops, jumbo loan rates will remain quite high relative to conforming rates.

Exhausted Population of Borrowers?

    Refinancing applications surprisingly dropped last week, despite the fact that primary mortgage rates indicators remained stable or declined.  The MBA's refi index (the best measure of activity) dropped by more than 20% week/week, and reported at its lowest level since the week ending March 13th (before the Fed's announcement of its Treasury purchase program).  Application activity softened in spite of a drop in the Freddie Mac survey rate, which matched its all-time low of 4.78%.

I can identify three possible causes for this decline:

           1)    the MBA's report is an aberration (possible);
           2)    the posted averages for mortgage rates are understating the actual rates quoted borrowers (unlikely); and/or
           3)    Borrowers are being told that they can't refinance due to credit or equity issues (likely).

If the last factor is the culprit, it means that the primary mortgage market is beginning to exhaust the available population of borrowers that have the credit, means, and equity to refinance.  Lenders and brokers should keep an eye on these numbers over the next month or so, as it could be a good leading indicator of how robust activity will be as we approach the summer.

Finally...a little fun for our aging baby-boomer population.   Every once in a while, I think about "Songs for the Financial Crisis," i.e., song titles that express my feelings while I watched the news headlines during the worst moments of the last few years.  A few of my favorites:

*"It's the End of the World As We Know It" (R.E.M.)
*"Dazed and Confused" (Led Zeppelin);
*"Crawling From the Wreckage" (Dave Edmunds);
*"Waiting for the End of the World" (Elvis Costello); and my favorite
*"It Can't Happen Here" (Frank Zappa).

I'd love to hear anybody else's Greatest Hits...hope you enjoy this exercise in perverse nostalgia.