MBS Pricing Snapshot

Stock charts actually provide the most clues here, and it's really mostly in stocks that we're seeing it play out, but for the first time in a long time, we're seeing a genuine "risk-off bid. That's a quick and noncommittal way to refer to stocks and bond yields moving lower together, ostensibly motivated by data or events that suggest lower risk tolerance and/or movement toward 'safety' (aka: flight-to-safety).

This was prevalent during the more dramatic months of the EU crisis and indeed is always possible depending on the data and headlines. We've seen some suggestion that news out of Portugal is fueling some of the weakness in equities as well as an alleged bomb plot in Canada.

Off the record, if pressed, someone else might suggest we're dealing with bored, jittery, thinly traded markets heading into a maelstrom of weirdness over the next few days--unsure how important tomorrow morning may be, unsure how many will even show up, unsure how many will show up Friday, and unsure whether or not NFP packs its normal punch or if we're just all holding off until September anyway.

Black and white thinking aside, the "risk-off" style headlines can't help but look less significant than the bigger-picture pre-NFP range trade, which looks like THIS. But we'll take what we can get in the short term--whatever the source may be. Fannie 3.5s are back up to 101-17, still 2 ticks down on the day and 10's are at their session lows at 2.4637. What once was negative reprice risk begins shifting positively above current levels, but we're not expecting many (if any) unless we break a bit higher. If this is truly a pre-NFP range trade, that's going to be very tough very soon.

While we haven't seen any NEW weakness materialize for bond markets, we are seeing liquidity thin out in both Treasuries and MBS at the same time that they're treading water near weakest levels of the day. 10's are right at 2.49 and a break higher could result in some extra momentum (2.495 even more so).

Fannie 3.5s are down 6 ticks at 101-13, a level they've been bouncing on for the better part of 2 hours. If we slip to 101-12 and below, the moderate reprice risk that's been mostly at bay could start to pick up again.

To reiterate: nothing has actually "happened" yet to increase risks, but it looks like there's more of a risk of that happening. Stay tuned...

What is POMO?

"Permanent Open Market Operations" undertaken by the NY Fed on a scheduled basis in order to buy predetermined allotments of US Treasuries. There are MBS POMOs too, but they don't follow the same sort of set schedule.

The most common time frame for Treasury POMOs is 10:15-11:00am ET. During that time, the Fed is bidding on pools of existing Treasury holdings submitted for consideration by dealers. The Fed only provides a range of potential purchases and can err on the high or low side of that range. This is occasionally relevant (if the actual purchased amount was near the high or low side of the range), but today's $1.46 bln compared to a $1.25-1.75 bln range is pretty central.

Other price pressures can occur before during and after the POMOs. Think of primary dealers as merchants selling similar goods. They have a client base that buys their goods. They buy and trade with each as well, and during POMO, they all hop in their wagons (metaphorically) and meet with the Fed to peddle their wares. Some merchants might be left with inventory they weren't expecting to have. Some might have seen other merchants leave with more inventory than expected, and all of them may have been less resistant to the idea of pushing prices higher before their wagon trip to the Fed (so the Fed buys at the highest price possible relative to surrounding movement).

That last bit is never something that dealers can predictably FORCE upon markets, but the notion of "less resistance to bond rallies heading into POMO" is probably a fair assessment. Whatever the case, volatility can ensue after the POMO results are announced at roughly 11:02-11:03am. The "classic case" is that yields spike briefly and return to previous levels.

From that point, however, trends can form (a caveat to ALL the ensuing discussion is that volume remains exceptionally low, thus discouraging us from drawing any firm conclusions about today's fluctuations). In today's case, the trend is very simply reinforcing resistance at 2.47 in 10yr yields or the 101-18 to 101-22 range in Fannie 3.5s. In both cases there has been a bit of overrun (and of course the 4 tick range in MBS is quite wide to be calling a "resistance" level, but this is a product of the progressive tightening of MBS to Treasuries where resistance has been moving up from 101-18 to 101-22 over the past few sessions), but the general theme is that the consolidative recovery rally is running out of steam at these levels.

While it does have negative short term implications for reprice risk, the sharper movement seen just over an hour ago was more to do with that post POMO volatility. Momentum is now "sideways" vs "risky" (though a lender or two might still reprice). Here are lines in the sand on the high and low sides for MBS and Treasuries that would suggest a change in that momentum:

- First line of defense against further selling: 101-10 in Fannie 3.5s and 2.495 in 10yr yields

- Second line of defense: 101-06 in Fannie 3.5s and 2.51 in 10yr yields.

- Upside resistance (crossing these is good): Fannie 3.5s at 101-16, 101-18, and 101-22. 10yr yields at 2.47 and 2.45 (and that's as low as 10's have been since June 21st!)

Fannie 3.5's are now down 4 ticks to 101-15 on volatility following the Fed's scheduled buying operation in 30YR Treasuries. Low volume and light liquidity are adding to volatility and some lenders may be considering repricing for the worse fairly soon.