I was thinking about the disconnect  between the primary and secondary mortgage markets today.  I had to laugh...

Agency mortgage-backed securities have enjoyed quite the rally over the last 40 days or so. Front-month delivery TBA prices have printed new record highs on a repeated basis. The street sees yield spreads near historic tights.  Investor demand for TBA MBS spread product is as STRONG as ever. Loan trading desks find multiple buyers when they attempt to sell forward their pipelines. Mortgage rates are at lifetime lows and fence sitting homeowners have seen their refi option creep deeper into the money.  The secondary market yearns for new loan production. There is more than enough money out there to fund a refi boom.

There is a problem though...

A mismatch between credit standards and the credit and collateral supplied by homeowners. Plus, the looming threat of a buyback always creates some sort of hang up, something always seem to go wrong, whether it be an appraisal issue or a random 40 pt decline in middle FICO, the unexpected is always to be expected. No deal is vanilla anymore. Making matters worse, the general public is distrustful of the origination community, this is compounded by a confusing regulatory environment.  Borrowers are distrustful of lenders and lenders are frustrated with borrowers.

Right when demand for agency MBS cash flows is roaring in the secondary mortgage market, the primary market can't churn out enough supply. Talk about a ****tease! That is why I had to laugh :-D

The disconnect between WHO QUALIFIES and WHO DOESN'T QUALIFY is just another example of the broken link in the distribution of wealth.  A 150bp LLPA for a 680 FICO mutter mutter. Seriously?

From a tactical perspective, this makes me think we might see a few failed trades in the production coupon side of the stack. Eh nah...but maybe a big old short squeeze that eventually leads to a duration shedding event down the road? Where is the Fed when you need a coupon swap?

WHY IS DEMAND FOR AGENCY MBS DEMAND SO STRONG?

MBS yields are higher than benchmark Treasury yields and the risk of investing is minimal for both securities because one is explicitly backed while the other is almost explicitly backed (it's def more than implicit).  Why pass on the extra return when they basically carry the same amount of risk?

Plain and Simple: MBS are benefiting from uncertainty in the marketplace. Agency MBS are enjoying a healthy "flight to safety bid"

I'm not sure how much longer this will last though, at least in terms of price levels in the short term. Risk markets are gaining momentum as S&P short sellers get squeezed out and the bear trap clamps down. This is the pain trade playing out in stocks. It isn't indicative of anything fundamental, so don't get frustrated if equities head higher, look in the mirror and repeat the following:  IT'S A TRADER'S WORLD AND WE'RE JUST LIVING IN IT, IT'S A TRADER'S WORLD AND WE'RE JUST LIVING IN IT

The last time S&Ps tested 1,100, traders rejected it aggressively. Well we're through 1100, and on Monday we'll for confirmation of this breakout.  If so, forced buying could take us up to 1130. If 1100 fails to hold positive progress, you know what happens: choppy price action in a wide range. 1090 is the first layer of support.

We were in this position just last week. The S&P touched 1110 and the 10 year traded up to 3.12%. Below is a chart of the 10 year note. I have overlaid Fibonacci retracements and an internal trend channel, the same one we've been watching for over a month. 2.85% is the clear cut winner for downside resistance. If rates sell, 10s first find firm support at 3.10%, after that, follow the dotted lines higher.

Here is a week over week loan pricing comparison. I don't have to tell you loan pricing is awesome right now.The week over week column compares today's pricing to the most aggressive rebate...EVER. If you want proof that lenders are looking to slow production, look at the spread between mandatory and best efforts pricing. It's huge at three of the major lenders.

Here is a look at the week ahead....

Investing outlooks are still very short term. In the past week we learned nothing new about the domestic economy that we didn't know already,  besides the Fed is more uncertain than usual. This implies the range trade will have played out in one way or another once the dust has settled. Play it until it plays you....