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Since peaking early this month, intermediate Treasury yields have settled back in the area of 3.60-3.65%. The uptick in rates, which peaked at around the 3.83% on January 8th, pushed the upper end of the 2 standard deviation band (a good indicator of its trading range) into the area of 4%, as shown in Chart 1. The width of the band has increased from its lows last fall, and is currently slightly above its averages over the period between September 2006 and 2008 (see Chart 2).
Mortgage performance has been spotty over the past few weeks. Chart 3 shows that the 30-year current coupon spread has widened by about 5 basis points over the past week, although it remains only a few basis points wider than its 60-day average. (At this point, it’s somewhat difficult for YieldBook users to look at duration-neutral performance over time, since they released a new prepayment model that has significantly different hedge ratios.) It is clear that passthroughs are trading somewhat shorter over the past couple of weeks; however, Chart 4 indicates that most coupons are still trading significantly longer than they were at the beginning of last December. 
Trading in the vol markets continues to be mixed. Realized volatilities remain quite low, particularly for longer-maturity assets, and short-expiry swaptions have pretty much tracked their decline. The longer expiries, however, have bounced around since the summer; as Chart 5 indicates, implied daily vols for 3x10 swaptions have ranged in the area of 8-9 basis points since last spring. 
Recent credit performance remains somewhat rocky. Chart 6 shows 60+-day delinquencies for loans in the Bloomberg non-agency data base continue to rise; disturbingly, 40% of Bloomberg’s subprime population is now D60+. The trend for shorter-term delinquencies has been mixed; subprime D30s have trailed off, while alt-A D30s increased last month. (See Chart 7 below) The D30 numbers are important, since they give the best indication of current performance trends; the D60 numbers reflect the huge pileup in the non-performing buckets over the past year or so. Overall, the trends in mortgage credit continue; the growth in new delinquencies is bottoming out, while the queue of seriously delinquent loans (and ultimately foreclosures) continues to grow. 
The home sales numbers have been disappointing, with both New and Existing home sales declining in November. The drop in Existing Home Sales was especially sharp, with SAAR sales dropping by more than a million units from November’s 6.54mm units. The decline was foreshadowed by the Pending Home Sales report and, to a lesser extent, by the MBA’s purchase application index. Chart 8 shows that the correlation between the Pending HS index and Existing Home Sales (shown as an index) has been extremely strong since the PHS index was first published in 2001. (Over that period, the correlation between PHS and both total and single-family EHS has been in the area of 96%.) In my mind, the falloff in new home sales is less relevant to housing, but more indicative of continued problems in the labor markets. What’s troubling is that the trouble in housing has eliminated many well-paying jobs for people without college educations, with a recovery being years away.
A few additional notes: - I’d be extremely surprised if the Fed didn’t end their program of mortgage purchases on schedule. However, the Fed will need to actively trade its portfolio well into 2010, since their purchases in the higher coupons have resulted in major short squeezes. The supply of Fannie 5.5s was reduced by $268 billion in July, reflecting both Fed purchases and runoff, leaving the dollar rolls trading at seriously negative cost-of-funds. I expect the Fed to actively continue selling dollar rolls in order to help alleviate liquidity problems in the higher coupons.
- The Treasury announced, on Christmas Eve, that they will offer unlimited support to the GSEs going forward (as opposed to the $200 billion ceiling for each firm previously in effect). In my mind, this reflects the Treasury’s desire to insure the perception of government backing for Fannie and Freddie, particularly before they are required to consolidate trillions of dollars of MBS trusts onto their balance sheet. (I’m not certain, but I believe the consolidation will be reflected in their Q1 2010 financial statements.) It’s unclear what effect this will have on their “earnings” report, but it is possible that the consolidation along will result in a massive charge against earnings for both entities.
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