Good Morning. After debt markets took one big step in the right direction earlier in the month, the rates market took two steps back last week.
In robust trading volume, the 10 yr TSY note yield rose 40bps....
...and the yield curve was 29 basis points steeper, as measured by 2s vs. 10s.
The steeper yield curve forced prices of "rate sheet influential" MBS coupons markedly lower. For the week the FN 4.5 moved from $100-19 to $99-10. If rate sheet pricing was totally tied to MBS price fluctuation, yield spread premium (base price + servicing) would have been about 125bps worse. However, as many readers may have noticed, primary/secondary spreads tightened last week as rate sheets were notably resilient while "rate sheet influential" prices fell....meaning lenders kept mortgage rates competitive relative to offer side price deterioration in the secondary market.
Illustrating price deterioration in secondary mortgage market: the FN 4.5 has completed 100% retracement of the late June/early July MBS rally....the FN 4.5 is now back to post FOMC price levels.
The reason behind this sudden change of sentiment? Stock markets bounced on better than expected earnings from several money center banks and a few major tech market participants...tack on some "not as bad as expected" economic data and you have a recipe for an oversold equity market rally. As investors allocated funds from risk averse assets to risky assets, benchmark TSY debt yields rose and stock indices skyrocketed through technical resistance levels. The S&P is over 5% higher in the past week...and pushing 2009 highs!
The dollar weakened against a basket of currencies...
...and Oil prices began to reflect the return of the reflation trade.
Unrelenting stock traders, a weaker dollar, and higher oil prices all had negative implications over interest rates. Consequently, fixed income traders began buying options to protect themselves from higher interest rates, and volatility in the rates markets rose, causing a snowballing of selloffs. After taking one big step forward following the late June FOMC meeting...rates markets took two steps back last week.
In the week ahead more earnings data, Bernanke on Capitol Hill, and a TSY auction announcement will move markets.
Almost a quarter of the S&P 500 companies are reporting Q2 earnings this week, including American Express, Boeing, Caterpillar, and Merck & Co. Markets will also see earnings from Amazon, Apple, Coca-Cola, eBay, PepsiCo. and Starbucks.
If you are looking for guidance on what Ben Bernanke might say in his semi annual report to Congress, READ THIS RECAP OF FOMC MINUTES.
The US Treasury is expected to announce $111bn in 2s, 5s, 7s, and 20 yr TIPS.
The lack of major economic data this week leaves MBS at the will of its benchmark big brothers, the TSY market (and swaps)...meaning MBS will take directional guidance from the gyrations of the yield curve. Look for buyers to take advantage of bargain price levels, and for sellers to take profits whenever possible. Range bound sounds like a legitimate outlook, but we must remind that this is a trader's market and whippy price action is quite possible as money flow momentum in one way or the other has the potential to defy technical and fundamental logic as market participants look to day trade for profits while the herd waits it out in cash. That means the stock lever is still wound tightly and all markets will likely be taking guidance from the sentiment in stocks. We will be watch for option volatility in equities to pick up for signs of weakness in stocks (plus market profile/volume at specific price points), we will also be monitoring volatility in interest rates, hoping for a fall. Look for the S&P to lose steam as it approaches the 946/950 level. In regards to fixed income, we will be looking for 3.72 to support further price losses on the yield curve.
Its been a roller coaster ride this month, what goes up must come down eventually...
So far this morning trading volume has been slow in the TSY and MBS market. I show one major trade in 10 yr contracts at 730EST (630CST) this morning. This block transaction could be described as "buying on weakness"...perhaps a sign of speculative buying at the lows. Beyond that early trade I havent seen much action in "rate sheet influential" benchmarks...310K 10yr contracts traded so far today, well below recent averages, this reflects a "wait and see" sentiment.
The S&P is also sideways, currently 5 points higher, testing 947 (see 946 retracement/resistance level on S&P chart above). Volume in stocks is light as well...overall market volumes are below average on this summer Monday morning.
In the MBS market, as benchmark big brothers have slowly ticked off of early morning yield highs, prices of "rate sheet influential" MBS coupons have sluggishly moved into GREEN territory. Currently the FN 4.5 is trading +0-01 at 99-11. Here is the slow and steady recovery from morning weakness...
Although rate sheets are worse today, they are not terribly worse...
2s vs. 5s: 149bpss
2s vs. 10s: 265bps
5s vs. 10s: 115bps
NYMEX Crude: 63.70
US Dollar Index: 78.99
VIX: 24.95
3m/10yr Interest Rate Volatility Proxy: 192bps (higher)
MBS Market Alerts
