A storm is brewing... 

But much in the same way that meteorologists are subject to certain margins of error when they warn of such storms, our impending storm, too, could buck the trends suggested by historical data and do something, well, completely different.  Nonetheless, in the absence of MBS trading or substantive financial headlines this holiday, let's zoom out to the 50,000 foot view and consider broader trends over the 3 day weekend.  At the inception of next week, as will be shown in the following chart, we embark on the next critical battle for MBS where we will re-test past assumptions alongside our other key market indicators: treasuries and stocks.  If the recent past is an indication, we may have more time left in this current upcycle, with the latter part of this week's weakness merely being a temporary dip.  But more pertinent than our current price level's predictive value is their significance as a "trip wire."  In other words, the fact that we have arrived at the crossroads, in and of itself, doesn't inform us much as to future directionality.  Rather, it's the "holding above" or "breaking below" of current price levels.  Whichever direction we move, according to recent historical data, suggests both a likely trading range for the next month or so and an unwillingness to re-cross current price levels during that same time frame.  The chart will help explain:

Yes, there's a lot happening on this chart, so let's break it down.  First, let's look at the top (MBS) half and the price levels of the 4.0 and 4.5 coupon.  As we've discussed many times in the past, a technical price level, whether it's a floor or ceiling, once broken, will now act as its opposite.  For instance, if a certain price level acted as a ceiling, meaning we've approached it a few times, but never broken through, once we DO actually break through, it's more likely than not that that ceiling will now act as a floor.  All this is from a "technical analysis" standpoint and as always, we will be sure to temper that analysis with the more important fundamental market data such as economic indicators, trade flow considerations, legislative developments, prepayment speeds, and headlines.  With all those other factors, why would we even pay so much attention to technicals?  Simply put, the MBS and TSY market, for several reasons, have been adhering to technical patterns to a noticeably higher degree than in times past.  The fact that technical analysis always helps to some extent notwithstanding, it has been particularly pertinent in these uncertain times where normal analysis correlations are seemingly disconnected.

So with respect to the above-referenced floor/ceiling concept, that's what we have in the two horizontal lines in the top section of the chart.  The red dotted line is a price level for 4.0's and the green line for 4.5's.  Taking a look just at 4.0's for now, we see a sharp break above that 99-20 level in December.  At that time however, we would not have known the trendline existed because it had never been tested.  The trendline was first suggested the SECOND time prices fell near 99-20 on January 5th.  This is what's known as a "double bottom" and was one of the primary reasons we anticipated an MBS price rally immediately following.  (incidentally, we got that price rally in grand fashion, as the graph shows, but not much benefit in terms of rates as the "primary/secondary" spread issues were emerging at the same time).  Near the end of January, we approached and held a third time.  This too suggested that the period immediately following would be price positive.  It was. 

But when we approached a fourth time, we fell through.  This is when technical analysis has it's most predictive benefit.  Since a "floor" has been strongly established with THREE relatively evenly spaced bottoms, all occurring at the same price level, technical analysis firmly suggests that it is not likely for prices to rise above that level again once they've fallen through for more than a day.  In early February, we fell through for more than a day, but immediately "re-tested" (meaning the curve rose again to nearly touch the once floor, now ceiling) and as the analysis would suggest, failed to break through.  Each time the curve re-approaches that line, it's called a "re-test," and with each unsuccessful re-test, the line becomes more and more significant.  Because we already had 2 significant re-tests in January from when the line was a floor, this retest as a ceiling hinted that this line might become hugely significant.  In mid February, TWO more retests were the nail in the coffin for the following month as you can see we did not break through until mid March.

Remember that Technical Analysis almost completely discounts headline news or the occurrence of any fundamental data.  We are simply studying the curve itself, without consideration for what the underlying security is, or what might be happening to affect it.  So the fact that the 2nd leg of the Fed's buying program is what helped us break through the ceiling does not matter.  We simply see the break through and conclude that our line SHOULD now be a floor again.  We got a chance to test that on April 3rd and lo and behold, the floor held.  And now you can see why next week may be a crossroads.  As of yesterday, we reached our first re-test of the floor in this cycle.  Looking at the green line and the green curve, we see a similarly statistically significant patterns of testing both as a floor and a ceiling of the 101-04 price level.  Serious floor all through January.  SERIOUS ceiling all through February and most of march.  But as you can see, we haven't approached the floor in 4.5's yet.  What might that mean?  HOPEFULLY it means "Down In Coupon," in that the 4.0's, from a technical standpoint, have the ability to outperform 4.5's because 4.0's are at their floor, but 4.5's could fall a bit. 

In a bit of a twist, we have two things to consider.  First, remember that the floor tells us more about the future AFTER it's broken.  Remember the "trip wire."  But, in this case, we should also take a look at past suggestions.  BOTH the 4.0 and 4.5 coupon touched their floors THREE times before breaking through on the 4th.  If the trend holds, this is only our second touch in this cycle, suggesting we could stay above the floor forr as long as we did from mid December to Late January.  Also a mark on the positive side of the column is the fact that we did not quite touch the all time highs from early january.  That pattern suggested an initial high spike, two floor tests, and a third, even higher rally before decending for the third and final floor test.  In the past, the mega rally came right after the 2nd floor test, which is where we begin Monday.  I'm sure we're all hoping for Mega-Rally-Time, but it might not be that simple.

Look at the curve from Jan 5th to Jan 26th.  It looks very similar to the curve (in 4.0's not 4.5's) that we've just had since March 16th.  According to that previous curve, Monday would be the turning point at which we break lower and stay there for a while.  Looking over years and years of MBS price graphs, one notices the uncanny ability of these graphs to repeat the same patterns (that's where the Fibonacci retracement level theorists get credence).  So, like always, there are possibilities in the curve that suggest opposite actions.  Now is the time where  you sprinkle in your own beliefs and experience to draw your own conclusions.  Once can see that the treasury and stock charts allow for differing eventualities as well.  3.08 has been a solid ceiling for the 10 year, VERY solid.  It might be tough for MBS to tighten enough to stay above their floor if the 10 yr re-tests 3.08 over the next couple days.  Beyond that, a lot can depend on equities, and we know there is plenty of differing opinion there.  Yes, it's possible that early march could have been "the bottom" so many have been looking for.  But there's plenty of overhead resistance and plenty of pessimistic analysis to make that more than an even debate.

Bottom line, uncertainty persists in the highest degree.  Although, we can be reasonably certain that reasonably low rates will be around in the coming months, 5.5 versus 4.5 is a huge difference to the mortgage professional.  So do whatever rain dances you need to do in order to get our 99-22 level of 4.0's to hold.  Remember that a short thursday before a three day weekend is always uncommonly volatile and usually not indicative of movement come Monday.  If only there were 100% correlative analysis for this stuff, we could get some more sleep this weekend.  But I think the fact that lenders tend to hedge a bit over long weekends and hopefully the fact that markets did too should keep us relatively stable Monday in lieu of headline tape-bombs.  After that though, my fingers are crossed for the best and my gut is GUT-FLOP'd for the worse, just like you.  Happy Holidays from MG, AQ, and all of us at MND.