MBS Pricing Snapshot

10's are on the verge of breaking above previous high yields and MBS are just stepping into new lows for the day as the late-day leakage officially begins. Fannie 3.0s are down nearly a full point at 101-25 and 10's are up 10bps to 2.0333. Additional negative reprices are possible.

As feared/hoped/surmised, the Minutes from the most recent FOMC meeting didn't include any meaningful surprises that hadn't already been conveyed by Bernanke earlier this morning or in other Fed speeches over the past two weeks. While we're not sure the Fed has really done anything to "map out" a tapering plan, per se (as suggested in the May 10th Hilsenrath article), they have more or less copped to tapering being on the table.

Mapping aside, the notion that the Fed was "closer to tapering" than markets may have previously anticipated is one of the key bearish themes for bond markets over the past two weeks. An absence of tapering verbiage in today's minutes would almost certainly have reversed much of those losses, but that was effectively ruled out when Bernanke himself discussed tapering being possible some time in the upcoming 3 meetings. The only way a Fed member could have done any more to prepare markets for today would have been to say "The minutes on May 22nd will reference that some of us thing we should taper soon."

Net/net, the Minutes were about as balanced as one would expect given the recent communications, but if we rewind to late April, the current tenor would seem downright precipitous. In that regard, the first 3 weeks in May have done an extraordinary job of getting expectations in the right place, but unfortunately that's still a bad place for MBS and Treasuries. It's a place where we understand that the Fed is going to keep buying long-term assets, but one in which there's clearly a drive to reduce the overall amount of those purchases in order to mitigate system shocks in the future.

In other words, they don't want QE to end like it began--with an abrupt change to the balance sheet of many hundreds of billions of dollars. Instead, it seems clear the Fed wants to ease us into things this time around. Metaphorically, "adding QE" is like an ER visit whereas "removing QE" is like weeks and months of physical therapy.

Bottom line, even though the "hype" isn't this massively negative realization for bond markets, it is still very real, and precludes a triumphant directional bounce back for bond markets. On the bright side, we've gone no lower since the Minutes release, but neither have we really done much at all. Without fear of exaggeration, today was all about Bernanke this morning. The biggest movement in prices and volumes was seen then, and it was left to Minutes to either confirm or surprise. They didn't surprise and here we are hovering just under 102-00 in Fannie 3.0s and just over 2.0 in 10yr yields.

Negative reprice risk still lingers for some lenders, but shifts positively for most as long as we continue to hold near 102-00. Keep in mind that a positive shift for most means that we get back to neutral, with only one or two aggressive types standing much of a chance of a corrective positive reprice at this point. Prices have been trending lower since 2:16pm, so we wouldn't get our hopes up for anything yet, and would stay very guarded about negative risk if you haven't seen a negative reprice in a few hours.

"Participants also touched on the conditions under which it might be appropriate to change the pace of asset purchases. Most observed that the outlook for the labor market had shown progress since the program was started in September, but many of these participants indicated that continued progress, more confidence in the outlook, or diminished downside risks would be required before slowing the pace of purchases would become appropriate. A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome."

"One participant preferred to begin decreasing the rate of purchases immediately, while another participant preferred to add more monetary accommodation at the current meeting and mentioned that the Committee had several other tools it could potentially use to do so. Most participants emphasized that it was important for the Committee to be prepared to adjust the pace of its purchases up or down as needed to align the degree of policy accommodation with changes in the outlook for the labor market and inflation as well as the extent of progress toward the Committee's economic objectives. Regarding the composition of purchases, one participant expressed the view that, in light of the substantial improvement in the housing market and to avoid further credit allocation across sectors of the economy, the Committee should start to shift any asset purchases away from MBS and toward Treasury securities."

"Members generally agreed on the need for the Committee to communicate clearly that the pace and ultimate size of its asset purchases would depend on the Committee's continued assessment of the outlook for the labor market and inflation in addition to its judgments regarding the efficacy and costs of additional purchases and the extent of progress toward its economic objectives. To highlight its willingness to adjust the flow of purchases in light of incoming information, the Committee included language in the statement to be released following the meeting that said the Committee was prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes."

"the Desk's survey of primary dealers, conducted prior to the April 30-May 1 meeting, indicated that the dealers continued to view the third quarter of 2015 as the most likely time for the initial increase in the target federal funds rate. The median dealer anticipated that the FOMC would maintain its current pace of asset purchases through December 2013 and saw the second quarter of 2014 as the most probable time for the end of asset purchases, implying a slight upward revision to the projected total size of the Federal Reserve's asset purchase program."

After Bernanke said that the FOMC "could take a step down in the pace of purchases in the next few meetings," it was off to the races for bond markets. The sell-off was covered in the last alert, but what now? It's not as if Bernanke said anything that markets weren't already prepared to hear and nothing very different from the recent batch of Fed-speak suggesting the same.

Perhaps those similarities are reflected by the fact that MBS and Treasuries merely hit their weakest recent levels without breaking through. But after the Q&A ended, imaginations are running wild and MBS are revisiting their weakest levels of the day, as are Treasuries.

Given the tenor of Ben's comments, this doesn't create an overly complicated scenario. Reprice risk should be assumed to be omnipresent, so unless we break meaningfully into weaker territory, we don't have much to lose.

That's not to say that won't happen, but importantly, it has yet to happen, and it's the levels at the end of the day that will matter most in the bigger picture. We're still holding on to yesterday's support at the price lows in both MBS and 10's. Support levels notwithstanding, we wouldn't be surprised to see extra volatility between now and then--i.e. support levels getting stretched and uncomfortably tested (well, in fact, this just happened as I typed that, so there ya go. Go ahead and scratch that "it has yet to happen" nonsense).

10's up to 1.9998 and Fannie 3.0s down to 102-05. To reiterate, reprice risk is ongoing, and highly likely if you haven't seen one yet. Quicker lenders will be coming around for a second pass in some cases.