Economic problems abroad are taking a toll on the U.S. market for mortgage-backed securities.
Overseas and domestic investors have rushed to buy Treasury securities in recent months, seeking shelter as trouble flared in Asia and spread to other continents.
The strength of Treasury securities has made them more attractive than higher-yielding mortgage-backeds. And the flattening of the yield curve has reduced the value of mortgage securities.
A Treasury bond is viewed as "a risk-free asset, which has the umbrella of an appreciating currency," said Rajiv Sobti, managing director at BlackRock Inc., who manages a huge mortgage-backed portfolio. The tremendous popularity of Treasuries could be fueled by continued turmoil in Asian, Latin American, Russian, and South African economies, he said.
"There's still so much uncertainty about Asia that at least for another month or two it's likely to override other factors," said Henry Willmore, senior economist at Barclay's Capital. "The market hardly reacts to U.S. data."
The movement of investors out of Asian assets and into U.S. markets raises the dollar's value versus the yen and boosts bond prices at the same time, said Mr. Willmore.
Since early April the correlation between dollar-yen exchange rates and bond prices has been almost 0.9, a high point that is "very unusual" and that indicates "investor sentiment about Asia has been the dominant factor in both markets," Mr. Willmore said.
More capital is flowing toward Treasuries while supply continues to shrink, Mr. Willmore said. The Treasury Department is issuing less than it is redeeming, because ofthe balanced budget.
Investors owning yen have moved to trade for dollars and then to invest the dollars in some kind of dollar-denominated, interest-earning asset, said Carol A. Stone, director/deputy chief economist at Nomura Securities International Inc. The Treasury market is the most liquid destination for these dollars.
"You're seeing some buying by mortgage accounts of Treasuries, to offset the effects of accelerated prepayments," said Rich Schwartz, chief investment officer for stable-value securities at New York Life Asset Management in Parsippany, N.J. This shifting of funds has driven up the spread between mortgage securities and Treasuries.
"Low yields in the short end of the Treasury curve have encouraged investors to go out further, and that has contributed to the flattening of the yield curve" in the United States, said Ms. Stone.
"A flat yield curve presents problems for mortgage investors," said Bill Quinn, director at Smith Breeden Associates Inc., Overland Park, Kan. "With low rates and a flat yield curve, adjustable-rate mortgage prepayments are extremely high."
The difference between the rate on an adjustable mortgage and the fixed rate that a borrower could refinance into has led to significant prepayments, Mr. Quinn said. This has caused losses for investors in adjustable-rate mortgage securities, such as Capstead Mortgage Corp., and for real estate investment trusts that buy adjustable-rate mortgages, such as Thornburg Mortgage Asset Corp.
"Rates are very, very stable. They actually have come down a tick or two," said Richard DeAlmeida, mortgage loan representative at Citizens- Union Bank in Fall River, Mass. Citizens-Union is making a lot of construction loans, he said.