Have you noticed a lack of MBS specific analysis on the blog lately?
We havent been discussing MBS duration or educating on embedded options. We've left out spread speak and ignored the index. There has been a decrease in convexity related commentary and no mention of implied funding costs.
Instead its been much of the same....trading flows slow, Federal Reserve provides 2x demand side support to originators looking to offload their pipelines of loans, servicers hedging, banks and insurance funds buying on weakness while fast money accounts continue to trade "up in coupon". Range bound. Parnertia. Directional guidance giver. Benchmark big brother.
Although we've provided pertinent points, MBS commentary has been noticeably absent from the MBS commentary blog. Instead you've seen convoluted futures charts, watched moving average momentum, read about implied volatility, learned about retracement levels, and studied market profile.
More than anything youve heard this phrase over and over and over again.....
It's a Trader's World, We're Just Living In It
Why?
Your rate sheet influential MBS coupons are not taking their cues from MBS supply and demand technical's. Slow trading flows have left mortgage-backs at the mercy of the gyrations of the yield curve. Price movements have been based on the directional guidance of benchmark big brother TSYs (and swaps). As MG stated in the past...MBS HAVE BEEN AN INNOCENT BYSTANDER TO MARKET VOLATILITY.
This is a function of a MASSIVE amount of uncertainty in the marketplace (and a whole bunch of barriers in the primary mortgage market...mutter mutter). Half the market says recovery, the other half says stagnate stabilization. Half says test October08 highs, the other half says test March09 lows. Its the BIG PICTURE battle between the bulls and the bears.
No accurate assumptions can be made regarding the "road ahead". The labor market remains incredibly weak as companies just finished cost cutting and have no intentions of hiring (broad based...you can pick individual sectors who are hiring). A weak labor market has negative implications for consumer spending. Weak consumer spending has negative implications for business spending. Weak business spending has negative implications for commercial real estate. Weak commercial real estate has negative implications for community banks. Its a trickle down downward spiral and every attempt to model expected outcomes has a massive amount of consumer related UNKNOWNS baked into results. Yet perceptions remain relative..."better than expected" has overshadowed "less bad than expected"...the market has rallied on and on and on...and on.
With so much economic UNCERTAINTY...how can traders determine an accurate present value of future cash flows? How can stock valuations be considered correct?
They cant! So what are valuations based on?
Supply and demand technicals. Willing buyers find willing sellers.
The same way housing prices inflated in the mid-2000s....willing buyers found willing sellers. Logic or no logic on value...prices moved irrationally higher and higher as more market participants turned buyers and less asked stopped to ask the question WHY SO MANY BUYERS? WHERE IS THE CROWD RUNNING TO? Nobody cared...everyone got a house, everyone stuffed their pockets with home equity profits.
Stocks appear to be acting in a similar
"freight train-ish" manner...slowly picking up passengers at each
breakout....each new rally chaser looking to cash in on the market's stubborn
sentiment to tick higher and higher. Nobody is stopping to ask WHY SO MANY BUYERS?
WHERE IS THE CROWD RUNNING TO? Nobody cares...everyone stuffs their pockets with profits.
Remember how the housing rally ended?
POP
This is
why you have missed out on MBS related educational commentary recently...a
bubble has formed in equities and fixed income investors have had to sit by and
watch...WAITING FOR GUIDANCE...in WAIT AND SEE mode. In the process...it's been a trader's market....price action has been moderated by technical strategies. This has forced us to adapt our content to keep you informed of reality.
That said...this month long period of "WAIT AND SEE" hasnt been all that bad. STATUS QUO HAS BEEN KEPT. At times the rates market has gotten a little frustrated...but we've managed to keep it together. The FN 4.5 actually managed to close July 2009 higher than it opened...all while stocks have been on a relentless rally.
NOW WHAT???
Last Thursday when the TSY department announced this week's auction amounts...market participants were a bit surprised to see surge in short dated supply. Specifically...$42 billion was $2 billion more two yr notes than most were expecting...especially after the previous six two yr note auctions were unchanged at $40 billion. Earlier that same morning a very specific trade was made...
This trading strategy is called a "Notes
Over Bonds" spread trade. The underlying assumption of this speculative
positioning was the notion that the yield curve would need to flatten for this
trade to pay off.
Plain and Simple: this strategy illustrates one trader's/account's bias
that the spread between long-term TSY rates and short term TSY rates is going
to narrow as the yield curve flattens.
To recap this week auction activity... the shorter dated supply, 2 yr notes and 5 yr notes, auctions did not go well. This was a function of supply and demand and the coupons that the Fed purchases in the open market (Fed TSY purchase program). TOO MUCH SUPPLY OF 2s and 5s on the market!!!!
So...to profit from this SUPPLY > DEMAND sentiment, traders began to bet that the yield curve would flatten out in the week ahead...guess what happened this week.
THE YIELD CURVE FLATTENED!!!
My Point.
The market knew what it was doing.
The fixed income market began setting itself up for this trade last Thursday. As soon as the auctions were over and supply was behind us....RALLY TIME. Regardless of what stocks were doing...prices are back to where they were last Thursday when the Treasury Department announced supply.
BACK TO STATUS QUO!!!
Looking Ahead....
TSYs have detached from the stock lever several times this month...but have consistently returned to status quo. At this point in the strategy cycle...traders have put themselves EXACTLY IN THE MIDDLE OF THE RANGE.
Illustrating middle of the range in yield. Note 50% retracement....
Illustrating middle of the range in price. Note 50% retracement...
My point.
Although we've spent much of the month detached from TSYs we have returned to status quo...we are back at the mercy of the sentiment of stock traders. We are set up to rally. We are also set up to selloff. There is room for rates to move lower, there is room for rates to move higher.Waiting for guidance...back in wait and see mode.NO TREND HAS BEEN CONFIRMED.
Now for you lock/float advice....
To take an excerpt from a post I still find quite relevant....The Big Picture. Back to Rate Sheet Reality:
With fixed income taking directional guidance from a group of profit hungry traders (DEALERS)...are you willing to bet your income/mortgage payment on the behavior of these market participants?
We say, even though the rest of the market is acting with a complete lack of logic, you shouldnt lose perspective of rate sheet reality. Manage your pipeline with a rational outlook. Look at the recent highs and lows of your YSP/offered mortgage rate...if your rate/income is at the better side of the range...DONT GET GREEDY! When deciding whether or not to lock or float remind yourself of the current volatile state of the rates market.
Plain and Simple: Yes. Stocks are STILL showing several signs of weakness. But this means nothing right now...technical trading strategies control market flows. Anything can happen! Dont forget how volatile the market has been, manage your pipeline relative to recent averages. If pricing/rates are good, dont wait for them to get better. Lock in when you have a good opportunity. Do we think rates COULD go lower in the future? YES WE DO. But probably not significantly better than they are right meow(haha)...at least not enough to justify the risk of further floating. We are at an inflection point and there is a ton of UNCERTAINTY surrounding market fundamentals. WE DO KNOW THIS THOUGH...MORTGAGE RATES ARE AGGRESSIVE RIGHT NOW.
Buy the dips and sell the rips people. Dont get caught watching the freight train going by...
FLOATING REMAINS SUPER RISKY
IT'S A TRADER'S WORLD, WE'RE JUST LIVING IN IT!
IT'S A TRADER'S WORLD, WE'RE JUST LIVING IN IT!!
IT'S A TRADER'S WORLD, WE'RE JUST LIVING IN IT!!!
Have a good weekend
AQ and MG
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