If we were to provide you simple list of closing MBS prices over the last 6 months--say a page for each month--and you lost the page corresponding to June, you'd never know about any sort of Black Wednesday related drama. In other words, prices ended the day very much in the middle of 2009's trading range. I'll give those of you who prophesied the "end of days" a moment to scrape yourselves off the pavement and climb back up here with the rest of us before continuing... Ready now?
What we're seeing is the unwinding of positions taken with perhaps too much fear of convexity and extension risk. Essentially, this means that fixed income securities with long durations, for whatever reason (credit rating, supply concerns creating inflation, rapid economic recovery, etc...) got really really scary in June, so scary in fact that they just might (understatement!) have become a bit oversold. So to "unwind" that trade would be to restore some balance to the force. Nowhere is the restoration of balance to the force ever more apparent than in a metric that almost every trader or analyst lists as one of the three they'd pack with them for extended stays on desert islands: the 2s/10s curve. Again, shifting to a simple explanation, the onset of all that fear we just talked about directly corresponded to a rapid steepening (also could be called "rise," or "widening") of this curve. You can see on the following chart that in the space of 2 days we're back down to our lowest post-blowout levels, putting us even with the previous floor. A move lower tomorrow would be a major technical positive, especially if Friday confirms. A move higher is also a possibility and though it wouldn't be as positive for the portion of the yield curve that most directly affects rate sheets ("rate sheet influential treasuries" perhaps?), it wouldn't be that big of a deal unless it punctured some previous high, which is unlikely.
The catalyst for the unwinding process in general, although diverse in composition, certainly counts the recent FOMC meeting among its catalysts, or at the very least, its turning points. Since then, sentiment has shown itself to be less and less convinced of several beliefs that were damaging MBS and long term treasuries: real and immediate inflation concerns, USA's credit rating, real and immediate signs of a faster-than-expected economic recovery, and of course the possibility of fed rate hikes in response to all that. Upon seeing that the sky was indeed not falling according to the FOMC, the race back to sanity has been slow, steady, and you guessed it! Waiting for guidance!
In short, today's 10yr auction was the most convincing guidance given. Why? a couple reasons... First of all, the 10yr is like the baseball and apple pie of the bond market. It's America's sweetheart to be sure, and for many of you mortgage types that have merely been plugged into the matrix lo these past many years as opposed to finding our wide offering of "red pills," it's all you have known by way of interest rate sentiment. Leaving the discussion as to the reasons for this aside, at least we can agree that the 10 yr is by far and away the most universally recognized treasury bill. To add to the significance of recent events, it was all the more scrutinized as it neared the 4% mark before the turn around, especially considering what a "big deal" it was to pros and amateurs alike when it went under 4%. To have gone back over by more than the few thousandths it did would have been a "big deal." But it did not. And until today, SLOWLY, of it's own accord has whittled its way back into a less nausea inducing yield space. But despite the gradual nature of the pull back, it has come quite a long way from a very heady level, AND in a relative vacuum of super potent guidance. This might leave many to wonder "is the 10yr really supposed to be back in the mid 3's or are all those volatility bets I'm hearing about just suggesting it bounces up and down a lot more?"
In some ways, today's auction answered that question. There we were at 1pm today, looking at a 3.4% yield... Something that many of us (and many of the more vocal comments on this blog) proclaimed would never be seen again. The last time we were actually fed by auction results to inform yield levels, we were fighting off something a whopping sixty basis points higher. I don't care who you are, you're a bigger person than I if you didn't wonder, at least for a moment, "has this pull back from convexity selling been overdone? And will today be the wake up call that lets us know that investors are not interested in the 10yr at these yields?" But my jaw literally dropped when I saw the high yield--with which almost 90% of the issuance was taken--come in 3.5 basis points LESS than pre-auction trading. Not since you found out your internet dating chat buddy was a mermaid have we seen such an unexpected tail ("tail" being industry jargon for the difference between the high yield and pre-auction levels). Part two of today's clear message was that the bid to cover was OVER 3.0. When there are three warm bodies for every sweater, you can bet that sweaters are in high demand. And part three... Not only were there three bodies, but about 1.5 of them were foreign buyers indicating that not only was demand high, but universally so... Long story short, it was about as good as it could have gone, and a HUGE MESSAGE sent regarding where we've been in terms of convexity panic. The message? "Um yeah, all that selling was a bit out of control, and truth be told, we're not really so convinced about a sweeping and uneventful recovery... Go ahead and put us down for a couple more orders of the good stuff please...."
If after hearing our thoughts on why Bernanke and Co. ostensibly "stood idly by" while yields skyrocketed you were still asking "BUT WHY!?!?!" Here's your answer. But better than some long winded blogger telling you all about it, let me show you...
Yes, you're seeing that correctly... The 10yr was at 3.3119 as of 5pm eastern. Whoah Nelly... Aside from the other obvious positive of the nice trend channel in MBS, we see a bit of a mixed bag as far as the S and P goes. On the bright side, it got capped out at yesterday's closing levels, but on the downside, it broke right through several intraday peaks as it rallied into the close. This of course means that it didn't break any downside resistance that might have more firmly suggested further selling and thus another potential fixed income boon. But MBS did break some topside resistance in the form of the highest point 4.5's have seen (by far) since MBS happy days in March, April, and May. But there is another challenge ahead. In Decemeber, January, and March, prices made lows in some significant ways noted by the yellow circles. This level, just a few ticks above us and corresponding with a decent level of "one oh one-ertia" might give our rally some pause tomorrow, but more than anything, just pointing it out to you. Moving up the scale of pertinence, you'll see that we broke above February lows yesterday and confirmed it today, also breaking through the highest point we've seen since the dark days began. That point from late may connected by the yellow line is even more significant still. If we hold above there, it's a good thing. Also high on the significance scale is the reasonable reliable "triangle" indicator denoted by the red lines. This was an incredibly aggressive triangle to hope to break on the upside, so aggressive in fact that we didn't even draw it for you as it would take some sort of hail mary to stay above the recent pace of higher lows. But we did, and so here we are...
As far as stocks go, you can see that no matter where you wanted to define the "neck line" of the "head and shoulders" technical pattern getting so much attention recently in the S and P, that is was broken today. Holding here or lower would constitute "confirmation" tomorrow (for most anyway--it's not quite enough of a break to count for some sets of sensibilities). That was the green line... Even more important would be the 870 level which we haven't seen since April!!! Not only that, but it turned back all comers going all the back to January!!!!! Needless to say that the heavily technically influenced SandP trading patterns will, at the very least, pause and scratch their heads with gutteral grunts if the index reaches down to this once-ceiling-now-floor. That's the nut I'd really like to see cracked tomorrow and confirmed on Friday to really stick it to all these so-called "optimistic people" Crush their hopes of economic recovery I say! At least the less than one tenth of one percent of our society comprised of loan originators will have some smokin' rates to deal with. Temporal considerations such as earnings may play a larger than ideal role in those movements however, as opposed to the more overarching long term fundamentals I think are bringing things back down in the first place. Hey... We gotta correct at least a little some time soon! When will it be? I don't know any better than you, but I do know the first and best place you can get the mortgage-specific analysis of those and other events, among other things...
2s vs. 10s: 241bps (Major FLATTENER!)
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