Interest Rate Jitters Hurt Mortgage-Backed Market

Interest rate worries have stopped some investors in mortgage-backed securities in their tracks.

"Mortgages have had a difficult couple of weeks, but it's not unique to mortgages," said Arthur Q. Frank, director of fixed-income research at Nomura Securities International.

He said everything has underperformed except on-the-run Treasuries-the most recently auctioned Treasury issues, which have the most trading volume.

In the 11 trading days that led up to last Thursday, the spread between the yields of mortgage-backed securities and the 10-year Treasury widened by 15 basis points, Mr. Frank said.

Ginnie Mae securities suffered the most, he said, with "a real lack of investors."

Some concern had been brewing about the prospect of rising inflation. But Joseph Abate, a senior economist with Lehman Brothers, said inflationary concerns are "a little bit exaggerated right now."

Such fears, he said, were driven by commodity prices. "Our view is that inflation is going to cool off in lockstep with the economy. We don't expect there to be any breakout in inflation," he said.

As for the housing market, Mr. Abate said "strong gains in the stock market, coupled with rising real incomes and booming consumer confidence, bode well for housing in general."

But he predicted some slowing due to rising interest rates, a trend that he said has already appeared in housing starts and existing-home sales.

One mortgage trader said the market was experiencing in- creased volatility caused by a widening of swap spreads-a generic credit benchmark that functions as a proxy for credit quality-coupled with the greater widening of discount mortgages compared to current-coupon and premium mortgages.

"There are a lot of fears of extension risk," the trader said.

With rates so low, the "lion's share" of the mortgage market is now in the 6% and 6.5% coupon, he added. Normally, the market for mortgage securities includes bonds with higher interest rates, he said, but it has been whittled down by refinancings.

"But now that we're backing up again in rates, that leaves most of the mortgage market at a discount," he said.

This leaves some investors struggling to find their bearings. "It's jittery out there," the trader said; "there's more volatility," which does not bode well for the mortgage market. Domestic economic data also have renewed prominence, after nearly two years of focus on international economic news, he added.

But these conditions also present some buying opportunities.

Mr. Frank of Nomura Securities said this is a good time to buy Ginnie Mae securities and current-coupon mortgages, because of the low prices.

Mortgages "should perform a little bit better in the near future," said William F. Quinn, a director at Smith Breeden Associates Inc. in Overland Park, Kan. He purchased mortgage-backed securities last week, especially because "prepayment concerns aren't as big of an issue," he said.

Allen R. Siegel, managing director for sales and trading at Blaylock & Partners LP in New York, favors the 15-year mortgage security in this environment.

"It is more of a refi vehicle than 30-year mortgages," so prepayments are more predictable, Mr. Siegel said. Also, he noted, there is less supply.

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