Investors were regaining their appetite for mortgage-backed securities last week.
"Spreads are dramatically tighter,'' said David Scherr, a managing director for Lehman Brothers, noting that the gap between mortgage- backed securities and Treasuries has narrowed by as much as 20 basis points. A narrower spread indicates greater demand, as investors are willing to accept less yield to take on the risk of the securities.
Analysts were recommending mortgage-backed securities, arguing that a dwindling supply, cheap prices, reduced risk that people will refinance the loans backing the securities, and a still-booming housing market made them a compelling value.
The securities were becoming harder to come by. Issuance of pass-through securities by Fannie Mae and Freddie Mac in June was at its lowest since March 1998, said Inna Koren, senior vice president of fixed income research at Prudential Securities. And she said issuance could dwindle further if interest rates continue to rise.
At the same time, Ms. Koren said, an "ideal environment for mortgages" is in the offing, considering the reduction in refinancings and strong home sales.
Refinancing risk has been reduced by the increase in mortgage rates.
Meanwhile, the housing market is booming, with 5.2 million units expected to be sold this year, up from 4.97 million in 1998, Ms. Koren said.
Mortgages "look very attractive versus other spread" products, said Allen R. Siegel, managing director for sales and trading at Blaylock & Partners LP in New York.
"Within the mortgage market there are enormous opportunities, particularly in going from pass-throughs into structured product," he said.
The decline in refinancings last week reached a point at which call protection could be bought for virtually nothing, Mr. Siegel said. Call protection insures investors against refinancings.
Mr. Siegel said he was buying structured securities -- particularly 10-year planned-amortization-class bonds, the most common component of collateralized mortgage obligation tranches -- because they offer call protection.
In the previous two weeks mortgage spreads widened to their biggest of the year. The widening was a result of hedging activity in the swap market, Ms. Koren said in a research note.
Ms. Koren and other analysts said conditions can only get better in the fourth quarter.
Lehman Brothers is keeping a positive outlook: The market is "setting up for some outperformance," Mr. Scherr said.