Magazine article American Banker

Treasury Rally, Refi Rise Calm Mortgage-Backeds

Magazine article American Banker

Treasury Rally, Refi Rise Calm Mortgage-Backeds

Article excerpt

After heavy trading in mortgage-backed securities for the first nine months of the year, a Treasury rally and an uptick in refinancing have helped cool off the market.

The drop in the 10-year-note yield to 5.8% on Oct. 27-the first time this year it had dipped below 6%-ushered in prepayment and supply fears, said Alec Crawford, a mortgage strategist for Morgan Stanley & Co. The high yield on the 10-year security was 6.98% on April 14. Although the downward trend reversed itself late last week, the yield was still 5.91% on Friday.

This year, a decline in implied volatility in the options market was a major contributor to the outstanding performance of mortgage-backed securities, Mr. Crawford said.

"Both the agencies and other market participants were able to buy mortgages and hedge out the negative convexity," or price compression, "either by buying options directly or by issuing callable debt at attractive levels," Mr. Crawford said.

In the last few months, however, the costs have escalated for Freddie Mac and Fannie Mae to issue their callable debt or for other investors to buy options to hedge negative convexity, and as a result it has become a buyer's market for mortgages, Mr. Crawford said.

At the same time, Treasuries have become more attractive.

"Treasuries are in short supply due to the fiscal position of the government and due to the near-balanced budget," said Craig S. Phillips, managing director for mortgage securities at Morgan Stanley. …

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