The bond market seeks new direction! As we have been explaining...mortgaged-backs are taking their directional guidance from the gyrations of the yield curve. A yield curve in seach of guidance itself.
READ MBS WEEKLY IF YOU DIDNT!!!
This week fixed income investors will be fixated on the feelings of equity traders (WHAT NOW?) and the looming TSY debt SUPPLY that is scheduled to be auctioned.... $35bn in 3 year notes tomorrow, $19bn 10s on Wednesday, and $11bn 30s on Thursday. During this process the 10 yr will be looking to locate a more stable trading range. Pre-NFP data release the UST10YR was violently bouncing between 3.50% and 3.75%. The post-NFP range that has started to develop is 3.72% to 3.91%...the bond market is still bearish, so logically we would expected to see "selling into strength" (and buying on percieved weakness (helps us figure out buyer sentiment)
Many have been asking...WHERE IS THE FEDERAL RESERVE? Are they still purchasing MBS? YES...OF COURSE THEY ARE!!! But notice this...they have been buying more 4.5 coupons and 5.0 coupons lately. This is due to the fact that mortgage rates have been on the rise and the majority of pools that back new MBS coupons are filled by loans with mortgage rates greater than 5.00%....
This past week the Fed spent a majority of their time fighting off servicer hedging strategies (straight up selling MBS) and absorbing whatever new MBS supply originators had in their pipeline. Remember there isn't much supply of newly produced MBS at the moment. Higher rates and the feeling of " WHAT NOW" (forced rates higher) have essentially emptied originator pipelines and left loan officers feeling dejected and desolate about the floating applications still in their stand ups.
Also when wondering where demand side support has been for "rate sheet influential" MBS coupons over the past week or two....don't forget, because of the steepness of the yield curve and colossal constraints borrowers face when applying for credit (mortgages), the rest of the MBS market...aka....non-Fed SOMA accounts....continues to buy shorter duration MBS coupons (coupons not as "rate sheet influential" like 6.0s and 6.5s)....we call this "UP IN COUPON". This is not new to us though...we have been observing this growing apathy of prepayment risk since early February.(Plus investors dont want to extend their portfolios into a time frame where inflation may be an issue...extension risk is big catalyst for "up in coupon" trade)
Reminder: eventhough many borrower's option to call their mortgage due is deep in the money, they have been unable to exercise it for various reasons...slow turn times (missed the boat), cant qualify, LLPAs, house didn't appraise (HVCC = BAD), lost job, lower FICOs, massive rates selloffs, etc, etc, et. Ok cool...but what about rate sheet influential MBS...when will rates come back down?
Well, we as discussed above and in the latest edition of MBS Weekly, the entire market is operating in a holding pattern sort of way...the market doesnt' know what's next...but remains at the ready for an assortment of outcomes. What we need is an event that shifts sentiment and helps identify a new range. An event big enough to sway the herd from "return seeking" to "risk averse". The Fed has a meeting on June 23-24...we believe by then the market will have forced the Fed to make a move. Maybe the market will convince itself that without a housing recovery, bank assets will deteriorate further (well maybe not with all the lending windows the Fed has open). Or maybe the Fed will open another lending window for TSY debt? Maybe TSY debt will become tax free? So much can happen...all is dependent upon what the majority of the market convinces itself is the right "feeling"...in the mean time, while fixed income traders await the broader market to figure out "WHAT NOW?"....we will be subjected to more technical plays and positioning and repositioning for auction activity. Professional traders will be protective of their portfolios, keeping a constant consciousness on volatility. The wider the range of expectations for the road ahead...the more volatility we have to deal with in prices and yields.
Trading flows (buying and selling activity) has been light so far this morning. The price beahvior of the FN 4.5 has been volatile...
This price volatility is a function of the negative convexity exhibted by MBS coupons that are deep in the discount (option is way out of the money)...therefore Matt and I are considering switching the current "rate sheet influential" designation to the FN 5.0...but remain hesitant to do so because we are not ready to wave the white flag just yet....should we do it?
2s/10s: 249bps
6/5 EFFECTIVE FED FUNDS: +0.01 to 0.21 from 0.20
LIBOR FIXINGS
O/N LIBOR: +0.0006 to 0.2612 from 0.2606
1 MONTH: +0.0025 to 0.3231 from 0.3206
3 MONTH: +0.0175 to 0.6500 from 0.6325
6 MONTH: +0.0788 to 1.2825 from 1.2038
1 YEAR: +0.2563 to 1.8537 from 1.5975
On Friday the market priced in a 100% chance that the Fed would raise rates by December. Consequently the benchmark 2 yr TSY note rose over 20bps in yield. This implies the market really is beginning to believe the economic recovery is on. We are keeping a watchful eye on the value of the dollar, gold, and the front end of the yield curve for any indications of a shift in sentiment....
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