Mortgage spreads to Treasury notes widened out somewhat from recent lows following the withdrawal of the Federal Reserve from its $1.25trn mortgage-backed securities (MBS) purchase program, although it was not the fallout some analysts expected. The June 2010 outlook from PMI Mortgage Insurance Co., the principal operating subsidiary of The PMI Group (PMI), suggests part of this widening may have little to do with the absence of demand and more to do with a broader economic flight-to-quality. The spread between 30-year fixed-rate mortgages (FRMs) and 10-year Treasury notes historically moved in a band of around 100 to 200 basis points (bps). In times of financial stress, mortgage spreads will blow up to more than 400 bps over Treasurys. By the end of 2008, PMI noted, mortgage-Treasury spreads shot up to around 300 bps, putting upward pressure on mortgage rates and bringing down demand. In response, the Fed began its agency debt- and MBS-purchase programs, which pulled in spread sharply to around 120 bps by the end of April 2010. But questions remained over whether the withdrawal of the Fed’s demand would cause spreads to widen out again. Analyst expectations ranged from a widening of zero to more than 100 bps, with PMI’s own estimate coming in at 25 bps of widening. About a month after the Fed’s program ended, spreads were up by about 45 bps, partially due to a flight-to-quality unrelated to the Fed’s program, according to PMI. But a coordinating rise in triple-A corporate spreads — which rose about 25 bps over the same period — indicates forces other than the end of the Fed’s MBS demand are driving spreads higher: “Removing that [25-bps rise] from the increase in mortgage spreads leaves about 20 bps as the impact of the Fed’s MBS purchase program’s cessation,” writes PMI chief economist and strategist David Berson. “Not only is this estimate on the lower end of the range but mortgage rates have been declining over the past month in reaction to the general flight-to-quality.” “Yields on 30-year FRMs have slipped by around 25 bps since the Fed’s program ended — but they might have fallen by about 45 bps if the Fed’s program were still in place.” Additionally, spreads between conforming and jumbo 30-year FRMs typically has been around 10-40 bps, but ballooned to more than 150 bps during the financial crisis. Over the past year, however, the jumbo-conforming spread dropped sharply to around 70 bps at the end of May. Berson warned the spread decline may overstate the scale of improvement in the jumbo mortgage market. “While the jumbo mortgage market may be better functioning than it was over 2008-2009, it still lacks the liquidity to allow for a full recovery in the upper-end housing market,” he wrote. “The recent successful (if small) private label MBS sale by mortgage REIT Redwood Trust is a positive sign, but it is just the first step in a long journey of recovery for the jumbo mortgage market.” Write to Diana Golobay. Disclosure: the author holds no relevant investments.
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