Wednesday, July 9, 2008

Mortgage Rates: Whipped in the Fannie...

Even after the Fed's attack (i.e. cutting the Fed Funds by 325 bps + opening up their balance sheet to add liquidity to the market) , rates on high quality (quasi government guaranteed) loans have risen. Looking at historical yields on Fannie Mae 30 year bonds one can see why...

Option adjusted spread "OAS" tells the whole story widening from an unbelievably tiny 7.3 bps in May 2003 from the incredible demand for CMO's and CDO's (before they realized it was a WHOLE lot easier to do synthetically) all the way to 154.9 bps (literally off the chart) in early March when banks / investors were selling anything they could get a decent bid for.

Where does it go from here? I do see light at the end of the tunnel for the OAS spread; not so much due to a rebound in demand or from a decrease in further delevering of banks, but rather in the decreased supply that will continue to hit the market in the coming months.

However, in my opinion, overall rates are likely to continue to rise as underlying rates rise more than OAS fall over the near term. This in itself would be very detrimental to the housing market and would increase the potential (can't believe I'm saying this for the third time now) for a deflationary environment.

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