Annaly/FIDAC Monthly Market Commentary: November 2005
(posted 12/9/05)

FOCUS

• The Mortgage Market : Prepays slow more than expected; the impact of raising the conforming loan limit
• The Economy : Other central banks tighten or at least threaten to do so; the economy grows without inflation
• The Markets : The dollar, gold and oil continue their winning ways; short rates continue to lose

The Mortgage Market

For the month of November mortgage prepayment speeds decreased more than expected for fixed-rate and adjustable-rate mortgages as the higher rate environment continued to weigh on refinancing incentives and slower seasonal factors affected mortgage originator activity. As we enter the winter months, prepayment speeds are expected to decline even further as slower seasonal factors remain. The MBA Refinancing Index now stands at 1596, about 18% lower than the current 3-month average and is 15.6% lower than the same period last year. As we mentioned last month, we will be paying very close attention to whether this slowdown is just the usual seasonal noise or if it reflects a slowing in the overall housing market going forward. The data so far has been mixed as we have seen a slowdown in the amount of existing homes for sale, but overall purchase activity and new home sales remain strong. Nevertheless, extension fears did resonate throughout the mortgage market in November as spreads on mortgage-backed securities widened several basis points relative to Treasuries.   

The Economy

November was mostly a quiet month, except as it related to central banks and their notion of price stability. The Fed surprised no one with its 12 th straight 25 bp hike of the Fed Funds rate on November 1. Gold topped $500 an ounce and platinum broke $1,000, prices not seen since the early 1980s. The European Central Bank raised its benchmark rate for the first time in five years, from 2% to 2.25%. Jean-Claude Trichet, president of the ECB, said that the action was taken in response to inflationary pressures but insisted that the institution had not decided to “engage in a series of interest rate increases.” Europe ’s finance ministers and the OECD had all urged the ECB to keep rates on hold. The ECB’s five-year period of inactivity would be considered remarkably long for a modern-day major central bank if the Bank of Japan didn’t exist. But even the Bank of Japan’s easy, accommodative and deflation-fighting monetary policy stance is being debated, as that country contemplates the possibility that prices may actually stop falling. “For several weeks this autumn,” explained The Economist, “the Bank of Japan…had seemed to be preparing the world for the beginning of the end, next spring or early summer, of its super-loose monetary policy.” Prime Minister Junichiro Koizumi, rather than being pleased by the strength of the Japanese economy, is not amused by the notion of the central bank doing its job. His administration is engaged in a rare public squabble with the BOJ and its Governor, Toshihiko Fukui, over the direction of monetary policy as well as the notion of central bank independence. Elsewhere, the Bank of Canada raised its overnight rate on December 6, from 3% to 3.25%.

While other countries may be in the preliminary stages of their tightening cycles, in the US the Federal Reserve is nearing the end of its cycle. Exactly how near is a matter of great speculation, scholarship and gossip. The minutes of the November 1, 2005 Federal Open Market Committee meeting were released on November 22 to the usual and customary breathless anticipation of the market. Combing through its 8 pages and almost 4,000 words, investors parsed and sifted through the document, looking for some indication of the Fed’s intentions. They think they found it in on page 7: “Some members cautioned that risks of going too far with the tightening process could also eventually emerge.” The stock market rallied on this nugget, and the Fed Funds futures market initially downgraded the potential for further Fed tightenings. The rally, like other false tops in recent months, was short-lived. Before the minutes were released, the futures market gave a 75% chance of the Fed raising rates to 4.75% at the March 28 FOMC meeting, downgraded that probability to about 30% right after the minutes were released, and as of today the market has brought the odds back up to over 80%. The March 28 meeting also happens to be the first meeting at which Ben Bernanke will likely preside.

There were several reasons why the market is so jumpy. First, elsewhere in the minutes to the November 1 meeting, members of the FOMC still expressed concern over “upside risks to inflation”. The inflation data released during the month was fairly benign. CPI, both core and headline, increased 0.2% in the month, with core rising at a 2.1% annual pace. Headline PPI rose 0.7% in the month, while the core number fell 0.3% to bring the annual rate of increase to 1.9%. Core Personal Consumption Expenditures, or PCE, the Fed’s favorite inflation measure, rose 0.1% in the latest reading or 1.8% on a year-over-year basis. Second, the minutes stated that “policy setting would need to be increasingly sensitive to incoming economic data.” That data has been fairly strong, with only a few signs of weakness. The Institute for Supply Management manufacturing index showed manufacturing activity remained strong. Jobless claims and non-farm payrolls were strong. Real gross domestic product was revised to 4.3% for the third quarter, a big increase from the advance estimate of 3.8%. Consumer confidence rebounded in November, and durable goods orders increased. On the weaker side, reports on the Christmas shopping season have been inconclusive at best. And the latest data point in the “signs that housing is weakening” watch is that pending sales of homes declined.

We will continue to monitor the economic data for any signs that would cause the Fed to change its current policy path, particularly the inflation, employment and housing data.

The Markets

The dollar, oil and gold have been the best performers over the past 12 months. The MBA Refi Index continued to decline, reflecting the higher rate environment.

Source: Bloomberg

This commentary is neither an offer to sell, nor a solicitation of an offer to buy, any securities of Annaly Capital Management, Inc. (“ Annaly”), FIDAC or any other company. Such an offer can only be made by a properly authorized offering document, which enumerates the fees, expenses, and risks associated with investing in this strategy, including the loss of some or all principal. All information contained herein is obtained from sources believed to be accurate and reliable. However, such information is presented “as is” without warranty of any kind, and we make no representation or warranty, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. While we have attempted to make the information current at the time of its release, it may well be or become outdated, stale or otherwise subject to a variety of legal qualifications by the time you actually read it. No representation is made that we will or are likely to achieve results comparable to those shown if results are shown. Results for the fund, if shown, include dividends (when appropriate) and are net of fees. ©2005 by Annaly Capital Management, Inc./FIDAC. All rights reserved. No part of this commentary may be reproduced in any form and/or any medium, without express written permission.