The long end of the yield curve, also known as the "rate sheet influential" side, it taking a beating today.

The 2s/10s portion of the curve is 3bps steeper ...now at 278bps. The market's knee jerk reaction to some form of a "tabebomb" (unexpected event) is obvious...

The yield curve can steepen one of two ways: Bear or Bull

A bull steepener is when yields in the front end of the yield curve are falling faster than yields in the long end of the yield curve. For instance, if the 2yr note yield was falling faster than the 10yr  note yield, then the difference between the 2yr note yield and the 10yr note yield would be increasing...the yield spread between the 2yr and 10yr would be getting higher, or wider.

A bear steepener is when yields in the long end are rising faster than yields in the short end of the curve. For instance, if the 10yr note yield was rising faster than the 2yr note yield, then the difference between the 2yr note yield and the 10yr note yield would be increasing...the yield spread between the 2yr note and 10yr note would be getting higher, or wider.

Right now, the yield curve is undergoing a BEAR STEEPENER. 10yr note yields are rising faster than 2yr note yields. The 2yr note is -0-02 at 99-28 yielding 1.052%...up 3 basis points in today's session. Meanwhile the 10yr note is -0-16 at 96-10 yielding 3.827%...6 basis points higher since yesterday.  Again...some form of "tapebomb"  caused sideways price action to breakdown.  This morning I said if the range were to breakdown...that 10s would likely test 3.84%. There is still room for this to happen so dont be surprised to see yields continue to move higher ahead of the 2pm release of FOMC Minutes.

How does the shape of the curve affect MBS coupons?

There is a tricky aspect to calculating MBS yields...you have to make an assumption on how long the MBS coupon's cash flows will last...more specifically you have to make an assumption on how fast borrower's will prepay their mortgage. While prepayment speeds are a function of supply/demand dynamics in the primary mortgage market (UW regs, funding, home equity, etc), they also depend on the shape of the yield curve. (More so supply/demand lately).

When the yield curve steepens, it implies interest rates will be higher in the future. If interest rates are expected to increase in the next 10 years, then the borrowers who are refinancing at current market interest rates will be less likely to refinance down the road because rates will be higher then vs. now. Who wants to refinance into a higher payment? Not too many people, there will be less incentive to refinance in 10 years if mortgage rates are higher than current market rates. That said, why would you want to invest in a current production (current market rate) debt coupon if rates are going to be higher in the future?

You wouldnt! This is called extension risk. When the yield curve steepens, demand for "rate sheet influential" MBS coupons usually falls....bad for mortgage rates. (However, lately no supply plus Fed spending has kept current coupon MBS yield spreads tight).

Plain and Simple: MBS buyers dont want to be stuck in a fixed income investment that isn't keeping up with its benchmark (benchmark yields higher than MBS coupon yield)...if benchmark interest rates increase, it implies rate sheet influential MBS holders could be investing their money in a higher yielding debt instrument...they could be earning more return/MORE CASH FLOWS!!!! (On a relative basis...yield spreads would be too tight)

Well... the result of the BEAR STEEPENER today has been plummeting "rate sheet influential" MBS prices and REPRICES FOR THE WORSE from lenders. Just like the 10yr note, some sort of "tapebomb" broke down the sideways price range the FN 4.5 was bouncing around.  The FN 4.5 is now -0-07 at 100-11 yielding 4.472%. The secondary market current coupon is 4.461%. Yield spreads are tighter vs. benchmarks...but off the early morning tights thanks to a round of selling from originators when prices hit session highs...this prompted profit taking from fast money accounts (hedge funds). The Fed has been the only buyer in size so far today...

If 10s test 3.84..."rate sheet influential" MBS coupon prices will fall further. BEWARE...

WHAT WAS THE TAPEBOMB I KEPT REFERRING TO????

INFLATIONARY FEARS!!! (cost push maybe, demand pull no way)

Add inflation headlines to NFP report anxiety, a little more ISM Non-Manufacturing Employment Index improvement, less corporate debt supply, and general profit taking.....and the market's nervous stance (bearish bias) is revealed. That bearish bias still needs to be CONFIRMED though. All of this movement is short term...short term = until Friday morning at 830am.

Just for fun...check out the SIZE of trades in the March 10yr Treasury futures contract....I highlighted the larger sell tickets. Trading is size is great in a rally, not in a sell off. It makes the market more illiquid and pushes prices lower much faster.

NEXT EVENT: FOMC MINUTES AT 2PM

We are going to be looking very close for Fed discussions on the MBS buyback program, plus any debate about the phrase: "exceptionally low levels of the federal funds rate for an extended period." The market will also be analyzing inflationary outlooks as well.