It looks as if we'll be able to fulfill that new year's resolution we've been putting off making: basking in the glow of the ever-elusive delivered promise for the MBS market.  Something actually happened as expected after a year devoid of "break catching."  In case you missed it, the news we've been waiting for--the appointment of asset managers for the $500bln fed purchase--hit the wire yesterday, and with an additional benefit to boot.  Not only were the asset managers announced (Blackrock, Goldman, Wellington, and PIMCO), but time frames were also specified with buying to start in "early Jan" and to consummate by June 31st.  This will make the Us Gov by far and away the biggest buyer in the market all year.  Indeed $500bln will be in the vicinity of consuming the entire annual MBS production.  It's a big deal. Rates are reacting accordingly, but "b-b-b-b-b-baby, we ain't seen nothing yet."

MBS are not exactly predisposed to the sorts of gains we saw at the end of the day yesterday (graph below).  Furthermore, this is movement AHEAD of the actual purchases taking place, which in and of themselves, will produce MORE movement.  History has informed us that this market wants to see "birds in the hand."  Out of maybe 10 birds, we got 1 or 2 when the announcment was first made, another 1 or 2 yesterday, leaving the lion's share to come when the purchase ink is dry.  The same thing occurred with Conservatorship.  The rumors helped a bit, the announcement of the deal being in the works helped a bit more, and the official inception of the conservatorship was the big mover.  It will LIKELY be the same here, giving us more positivity to look forward to barring unforseeable skyrocketing treasury yields.  Still, tsy's have the room to skyrocket a fair amount and MBS have plenty of spread yet to soak that up. 

Speaking of Spreads...

How about the spreads between primary and secondary pricing?  Primary pricing referring to the MBS prices we discuss every day and secondary pricing referring to that which lenders are passing on.  They've been quite wide, as we've been discussing for nearly a month now.  To revisit the "why:" consider the following:

• Lenders control their volume by adjusting their margins up or down.  The more competitive the rate, in general, the more business.
• The worse the rates, the less the inbound volume of loans.
• Obviously lenders can't afford to price better than primary MBS prices.  If they did, they'd be losin money.  In fact, lenders usually can't even price "rate sheet PAR" in line with MBS PAR. 
  
• They need a certain margin to cover their profit, G-Fees (guarantee fees for GSE's, FHA, etc...), and servicing.
• But they can certainly price worse than MBS.
• There has been a fairly standard "spread" between primary and secondary pricing.  In other words, if a 5.5% MBS coupon had a price of 100-15 to 100-25, we could reasonably expect a lender like Provident to have 5.5% be PAR on their rate sheet.
• Now, with 4.0 coupons being in that same price range, currently at 100-24, we are nowhere close to seeing any lender price 4.0 as par.  Furthermore, the lowest PAR rates, around 4.5, carry a primary price of nearly 102-00!  That's MORE THAN DOUBLE the normal spread between primary and secondary rates. 
  
• In other words, the difference between MBS price and what lenders pass on in their rate sheets is more than double it's normal value.

What Gives?!

1. We've declined in rates very far, very fast.
2. Remember that "prepayment speed," aka: the average length of time that certain mortgages with certain rates exist, is the most critical aspect to MBS valuation.
3. When we go through a period of stability where rates don't vary more than .5 to .75, it gets easier and easier for analysts to construct models that estimate the anticipated payoff speeds of new MBS.  After all if 5% coupons lasted for 7 years on last years stuff, and rates haven't moved much, perhaps 7 years will again be a good guess.
4. But things are anything but stable right now.  Not only that, but credit availability is slowly returning.  So lower rates and looser credit mean an INSANE amount of people with 5.5%+ rates will be refinancing, thus spiking the speed for those coupons. 
   
5. Furthermore, guesses as to where the rate drops will stop range from the high 2's to the low 4's.  That's a wide range to be guessing about.  If a lender thinks rates will get as low as 4%, then they'd believe the speed would be a lot slower than if rates got to 3%.  If rates got to 3%, many borrowers would refi, and 4% speed would increase. 
   
6. If that 4% speed increased, any MBS buyer that PAID A PREMIUM (meaning an MBS price higher than 100-00) would get burned, because they'd get their principal back without having a chance to earn interest on it over time.  (I have a feeling this #6 point might be a light bulb for many of us in terms of speeds, so read it again, and post in the comments if you still don't get it.  Don't be shy).
7. Ipso, ergo, therefore, thus, lenders can't give it up quite as fast as they have to wait for speeds to become more predictable.

But Wait, there's more:

1. There are yet more reasons for the gapped spread
2. many lenders operate with warehouse or funding lines.  In a boomy time frame, the funding lines can quickly become tapped.  Regardless of MBS price, lenders have to raise rates to discourage new apps as they become satiated.
3. The same concept applies to personnel capacity.  Some lenders that actually care about customer service realize they can't offer any if they price with MBS.  Lenders like Provident with an intensely originator-heavy cost and workload, and a very streamlined personnel workload, are able to operate a bit more nimbly in this market

Great, so how long before things return to normal?

Please see the above bullet points and numbers and you should be able to answer your own question.  We have to wait for lenders to catch up in terms of funding lines and personell.  That will get us part of the way back to normal, and then we'll begin a slow trickle as rates settle into their lows and prepayment speeds become more predictable.  A majority of the process could happen in the first quarter with the full process likely lasting months and months.

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Back on to daily MBS topics:

- Jobless Claims came in much better than expected.  So did NY PMI, but no one believed the readings, so markets have not reacted.  Treasuries are a bit sold in the middle of the curve, and a bit bought at the wides.  MBS is all green with dramatically tighter spreads and solidifying yesterday's nice gains and adding a bit as well.

4.0's up 15 ticks at 100-26

4.5's up 12 ticks at 100-27

5.0's up 10 ticks at 102-14

All levels well above base camp and on the last day of the year.  We'd expect things to improve even from here at some point in the next 3 weeks, possibly sooner.  Float Club.  Unless lenders pass on a ton of the gains, even short termers should float as long as possible.  If however, lenders pass on reasonable gains, short term deals might be safest locking as one never knows when "clarifying data" about a federal program will come out, changing prices rapidly.  But overall, float bias remains.