Before you get too excited at the sight of 3.50% across the headlines of a mortgage website , you should know that Treasuries are the topic of our focus at the moment. But lest MBS get jealous, the big picture remains intact, and despite the potential for rates to back up slightly, what's good for a 3.50 ceiling in 10's is probably good for a PAR(ish) floor in the 4.5 Fannie...
"PAR FLOOR?!?!" you say?
"That's a half point drop from current levels!" Indeed it is, but it would add some color to a bigger picture that's even more conducive to profitable origination than having the lowest possible rates. And pretty much the only thing we can think of that is both BETTER than the lowest possible rates and that ACTUALLY MIGHT HAPPEN SOON would be having rates very near those historical lows, except with more stability and predictability. In fact, you'll find when the post-meltdown pendulum stops swinging, the aforementioned stability and predictability will open the door for rates on lender's sheets to be slightly lower compared to MBS yields (primary/secondary spread tightening).
It was a day much like any other in Trader's Paradise. The events and concomitant market reactions should be well-read by now from the rest of today's commentary.
In case you missed it or otherwise want the refresher, here those are:
Moving on...Let's take a look a look at the implications of tonight's cruel and misleading title...
There are a few extremely important considerations surrounding the 3.50 level for 10 yr tsy's. And as is usually the case with price or yield levels of significance, they serve a dual role in both suggesting the slightly more likely shape of things to come and on the slightly less likely chance that they're broken, signalling the most serious risks of trend shifts. Indeed on that note, we think something more than a few standard deviations from expectation would have to transpire to shove the 'ol benchmark through this ceiling in any meaningful way.
Again, that's not necessarily good news in the short term as it leaves another few bps of recently unexplored yield overhead. But as mentioned, there are reasons to be happy about this resistance holding for the FOURTH time in less than 2 months, not the least of which are all the "punny" jokes that seem to so easily come to me... Oh... You wanna hear one? Ok... What's the difference between a shy clam and bond price curves?
One is a "quiet shellfish"
And the others are looking "quite shelf-ish"
If you can overcome that groan inducing knee-slapper, you'll see the shelves in question on the chart above. Mind the triple bounce in 10's post summer in addition to the FIVE bounces during the summer when the curve was coming from the other side of the tracks. And though there's too much noise to say all of that for MBS, the Sept and Oct trend is the same. Can it be that spreads finally reached cruising altitude? (aka, when the curves start to look more and more similar--in mirror image at least--it means that MBS and tsy's are spending more time going in the same direction.) Too bad Samuel L put snakes on that plane in the form of uncertainty about the post fed exit widening... But I digress...
In the short term at least, spreads remain intact in the range, so that which informs the longer bits of the yield curve informs the production bits of the MBS stack. Thus our focus on the yield curve is comparitively higher than it was. Does that make sense? If spreads look to have gone as low as they will, and have moved in a stable range within those lows, and we know the Fed's exit at the very least, does not suggest they'll go LOWER, then to a large degree we wouldn't plan on Mortgage yields being able to continue to defy tsy yields going forward. So any optimistic hopes of killer rates on the heels of unexpected tightening are likely misplaced. Conversely, in a world of historically low yields, MBS aren't seen experiencing a huge spread blowout either.
So if we're leaning towards 3.5 as resistance in 10's, we're therefore leaning towards PAR as resistance in 4.5's. Just remember the most dangerous part of resistance levels that SEEM to be good. They're almost ALWAYS more informative AFTER they're broken than before... So while we're more disposed to see 3.5 as some sort of ceiling, that speaks just as much to its function as a tripwire. With that, we're finally ready to discuss the chain of causility behind these thoughts. Not only because we're likely to revisit this in coming days, but also with an eye on the clock, we'll proceed with bullets.
- From both a short and even an uber long term perspective the 2's 10's curve is looking "peaky.." Without one of those 2-3 SD+ shockers, it will be hard pressed to go much wider.
- That means that wherever the short end of the curve is trading should be more informative than normal to the long end (and production rates). Just think of a dog on a leash, and the leash between 2's and 10's has stretched as far as it's willing. Only way for dog and master to be any farther apart would be some sort of precipitous breakage of said leash via above referenced mutli SD shocker.
- So if we've followed the chain of causality or correlation backwards from rate sheets to production MBS to the long end of the curve to short end of the curve (via go-no-wider spreads), it affords us the luxury of looking to the short end of the curve and actually having it MEAN SOMETHING about mortgage rates... Not all that common... quick recess and on to #4
- Short term rates are really the metric that's sensitive to those 3+ SD events via the anticipation and subsequent actuality of Fed policy. Statements and minutes have recently fallen well short of suggesting the need or even the agreement on the board, to raise short term rates in the near term. In and of itself, this thought could be a good enough stopping point in the chain of correlation back to mortgage rates, but for those that need to know WHY, there is numbers 5 and 6 which involve the Fed's mandate to "foster maximum sustainable employment and price stability."
- "Sustainable employment" is easy... Even the bull-lemmings of economic recovery are fond of spewing the overdone "remain weak into 2010" catch-phrase that any discussion on labor markets seems to necessarily contain. One down, one to go... "Price stability?" Um... Maybe a bit less of a consensus on that, but at the very least, in the short to medium term, it's hard to argue with today's CPI, especially considering the Fed is WELL AWARE that much of the recent stock strength that some view as a forewarning of "too much growth for such low rates" has not only been for reasons other than organic growth (read: cost-cutting, trading profits, borrow short, lend long...) but ultimately are the fruits of the Fed's own design! (again, read: borrow short, sell long... The Fed is making "short" = "cheap." The big dogs are cashing in.)
- Then, just when you thought the chain back to MBS couldn't get any longer, recent fed-speak has nuanced the traditionally two-pronged mandate with: "To achieve these goals, we must also support the return of financial markets to more normal functioning." And let me tell you, the massive ringing of the cash register that has some drawing a connection to future inflation is anything but "normal functioning" for financial markets..
There's even more to be said about why the markets are not nearly close enough to "normal functioning" for us to be concerned that this might trigger a shift in Fed policy and thus short term rates. But you and I both probably need to call it a night. And if 3.5 does anything remotely close to what we think it will, there will be plenty of opportunity to continue this discussion in the days to come...
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