This is a note my good friend and excellent lender over at Countrywide sent ot me today. Read it over.
The activity in Mortgage-Backed Securities (MBS) market – and other financial markets – has been very unusual this month. The Fannie Mae Required Net Yield has already made two round trips from about 5.70% to 6.60% over the past few weeks, displaying a level of volatility rarely seen. Under normal market conditions, the vast majority of the significant rate movements are the result of fresh economic news. This month, however, it has been common to see large rate movements unconnected to any news announcements, for reasons discussed below. One reason is that the credit crisis has forced many investment funds and financial institutions to reduce their leverage and raise capital. In many cases, these big holders of MBS are selling assets across their portfolios.This explains why MBS, stock, oil, and other markets have frequently all been falling on the same days. The fundamental economic data clearly supports lower mortgage rates. Global economies are slowing, oil prices are down, and expectations for future inflation are moving lower. As long as these investment funds are forced to sell assets, however, there will continue to be upward pressure on mortgage rates. How long it will last is one of the biggest questions facing investors today.

Rates moving higher this week has frustrated some buyers with all the talk about the Fed cutting rates. The Fed has control over short-term rates, which they are expected to cut by .50% today at 2:15pm. It is very common to see mortgage rates rise when the Fed cuts short-term rates. A second factor is that many investors are seeking to reduce the level of risk in their portfolios. They are buying Treasuries, mostly shorter-term,which are considered the safest and most liquid investment. These investors are generally not turning to MBS, and MBS prices have performed worse than Treasuries this month, meaning that the spread between mortgage rates and Treasury rates grew wider. The question is not whether investors will get their money back, but rather when they will get it back. MBS yield more than comparable Treasuries because MBS have prepayment risk and Treasuries do not.

The recent volatility and uncertainty in financial markets makes it more difficult to evaluate the prepayment risk, so investors are demanding higher yields and thus mortgage rates have gone higher.