OK let’s take a look at who’s buying what bonds…
The Treasury International Capital (TIC) report for August showed strong demand for dollar assets from foreigners.
Foreign inflows into Treasuries totaled +$43 billion, while corporate bonds and stocks saw +$11 billion and +$6 billion in inflows, respectively.
The inflow into US corporate bonds was the strongest since July ’08.
In Mortgage Land, which some say is between Candy Land and Nowhere Land, in August agency debt and MBS held overseas increased by $18.6 billion, which consisted of a $17 billion increase in MBS holdings and a $1.5 billion increase in debt holdings.
This was the largest increase in Agency holdings so far this year.
Within the MBS sector, the $17 billion in net purchases was offset by $14 billion in estimated prepayments, resulting in a net increase of about $3 billion in MBS holdings after accounting for prepays. Asia accounted for over $12B in net purchases in August, while Europe was also a large contributor with net purchases of $8B, mostly out of the United Kingdom and Luxembourg. (Shouldn’t they be using that money to buy their own debt – like we do?)
Good LO’s and well-run companies are continuing to say that demand is robust for home loans.
But few banks want huge amounts of 30-yr fixed rate paper on their books. The yield curve is pretty flat right now (20-year rates are only about 175bp greater than 5-year rates). Banks know, however, that long-term fixed-rate lending is at fundamental odds with its asset/liability structure. Put another way, when rates move higher and banks are paying depositors 4% on their money, they don’t want to be earning 2.5% on the mortgage holdings. Traders are seeing banks interested in interest rate swaps, since banks are compensated mostly for taking credit risk in the loan portfolio and not interest rate risk. An interest rate swap gives the borrower a fixed rate loan (stabilizing cash flow) while the bank enjoys a variable rate (better matching funding sources). Banks can continue to lend and earn fees, so while the underlying benefit of loan hedging lies in mitigating interest rate risk the primary benefit is continued lending.
But what residential agency mortgage-backed securities is everyone buying?
Perhaps rascally 2.5% 30-years, filled with sassy 2.75-3.125% loans? Or perhaps 3.0% 30-year MBS, filled to the brim with 3.25-3.625% loans? Or how about those ancient 3.5% pools, or even higher rates, with that big risk of paying off early? Maybe the borrower’s whose loans fill those pools can’t refinance!
The markets like to watch who is doing what, and the Fed is happy to oblige us with transparency. Recently the Fed has increased purchases in 30-yr 3’s at the expense of 3.5’s. And Fed gross purchases for the week ending October 10 were about $15 billion, lower than the $19 billion the prior week. This decline largely reflects the effect of the Columbus Day holiday and purchases remains consistent with buying $4bn/day. The Fed increased its gross purchases of 30-yr conventional 3’s to 53% of the total compared to 50% the prior week. This was accompanied with a decline in 3.5’s to 6% from 9%. The overall share of 30yr conventionals remained steady at 60%. The Fed also purchased $150 million in Fannie 2.5’s. The purchase share of Ginnie 30-yr 3’s also increased slightly to 14% from 13% the week before, while 3.5’s declined to 5% from 7%. The Fed continued to stay out of the Ginnie 15-year sector, but purchases of 15-yr conventional 2.5s stayed at 18% of gross purchases. Overall purchases of 15-yr conventionals were also steady at 21%, and for the first time the Fed purchased $150 million in Fannie 2’s.
On the hedging side, traders report that the overwhelming hedge coupon of choice was the Fannie Fannie 3% with over 80% of 30-yr hedge activity in that coupon compared to over 90% last week. The 30-yr 2.5% coupon has been slow to gain liquidity, and is less than 2% of hedge volume.