MBS MORNING: Unshakable Uneasiness...Waiting on the Fed

The unshakable uneasiness regarding the growing government debt load and the US credit rating continues to cast a dark cloud over the bond market...all while stock traders are enjoying a prolonged period of over-eager economic exuberance. Yesterday, while GM inched closer to bankruptcy and the S&P reported that home prices were showing little signs of stabilization (see below), the equity market found some post weekend vitality in WAY better than expected consumer confidence data (54.9 after 40.8 in April). The Dow rallied 196 points (2.37%) to 8473, while the NASDAQ moved 58.42 points higher (3.45%) and the S&P rose 23.33 points (2.63%) to 910.33.

Regarding the consumer confidence data....although 10.2% of the surveyed consumers said they believed their income would increase in upcoming months (8.3% in last read).... only 2.3% of consumers said they were planning to buy a home....down from 2.6% in April. The expected lack of housing demand should have weighed on financial markets....as housing must stabilize if asset deflation is to decelerate and bank balance sheets are to be appropriately mended.

(The S&P/Case Shiller Home Price Index data release which indicated that home prices had fallen 18.7% in the last 12 months...S&P Index Chairman stated that " declines in residential real estate continued at a steady pace into March". All 20 metro areas are still showing negative growth rates...with 9 out of 20 metro areas having record declines)

Bond market participants continued to price in a bit of "reality" yesterday.... $101bn in supply this week and $65 billion in two weeks....that's a lot of coupons for an already oversaturated marketplace to absorb. Early in the session TSY traders covered some short positions (slight early morning rally) before the WAY BETTER THAN EXPECTED consumer confidence data sent the 10 yr TSY note 10bps higher to 3.54% by close. On the day...the yield curve moved steeper by 12 bps to 263 bps....as measured by 2s/10s.

Mortgages on the other hand had an dull day...from a trading perspective at least. Volume was below normal with the Federal Reserve being the only buyer of quantity. Most accounts sat on the sidelines...happily watching prices cheapen...waiting for a change in fixed income sentiment....searching for the right re-entry point. The primary mortgage market was not so lucky though...as reprices for worse were widespread. Since last Thursday your rate sheets have lost around 125 bps.

Today we continue to battle debt supply and the continued notion of a more optimistic economic tone. The TSY will auction $35bn 5 yr notes at 1 pm after the National Association of Realtors releases Existing Home Sales data at 10AM (expecting 4.66 mln vs. previous 4.57 mln). (FHFA Home price index at 10am too....ugh). The stock market is looking to carry on its "warm and fuzzy" feelings after yesterday's WAY better than expected Consumer Confidence print while Treasury traders remain extra attentive of their open short positions...looking to cover into any mounting momentum as sellers still control the market. There is indeed still a defensive bias in the fixed income marketplace as the Treasury bubble, the US credit rating, and the "ghost of inflation yet to come" combined with "economic optimism" are wreaking havoc on the yield curve.

Extension risk is now the big focus in MBS world...

When benchmark Treasury rates rise, the expected life of cash flows of "out of the money" (at par or below par) MBS coupons grows longer. The farther out of the money an MBS coupon is... the more it's duration (life) will EXTEND when benchmark rates rise. This occurs because borrowers backing those MBS pools will have no reason to refinance if their rate is below current market. This means "current coupon" MBS investors are then STUCK in an investment that is paying less than what the market is offering!!!

Plain and Simple: If benchmark interest rates move higher, funds can be reinvesting at current market for a higher yield and more return. Because the holder of MBS coupon can't call the debt due (only a borrower has call option on their mortgage) they will be stuck in an investment that is UNDERPERFORMING. Hence...stay away from anything extension risk related...stay away from "rate sheet influential" MBS coupons.

At this point everyone wants to know WHAT, WHEN, HOW, and IF the Federal Reserve is going to flatten the yield curve. Until then...the Fed is going to be left to their lonesome to fend off originator supply offerings...

PS...we are watching servicer hedging strategies for a sign of weaker "rate sheet influential" MBS prices to come

MBS QUOTES