For one of the only times in the history of the MBS Close, the entire commentary is obviated by the title. With little if any data that anyone really cared about and the much more significant treasury auctions and FOMC announcement coming up in the belly of the week, there was no reason for traders to turn up the juice enough to conjure much more than half of the already low summertime volume. Apart from the ostenibly pleasurable feelings associated with an 18 tick rally in 4.5's, there was not much to get excited about. When you consider what AQ already mentioned, in that this simply returned us to a status quo before data, it truly was a correction of NFP induced reaction mechanisms.
Most likely, the FOMC announcement carries a bit more weight than tomorrow and Wednesday's auctions since all 3 of those data points would have to be considered together before arriving at any definitive conclusions. This places the 30yr auction in a league of it's own as far as impacting fixed income trading. Essentially, it has more potential impact than the 3 or 10yr considering that it is the only one of the 3 that comes AFTER the FOMC announcment. Using that same logic also creates the potential for most of the early to mid-week volatility to arrive after the FOMC announcement.
This isn't necessarily because any major surprises are expected to come from Ben and the gang, but rather because at least some of the reaction to the first two auctions will be on hold until the FOMC announcement has its chance to confirm or refute the suggested direction from the auctions. One thing potentially working in the favor of auctions this week is the extent to which rates have risen since the previous auctions. A fairly rapid back-up in rates has been built into current trading and the last time this happened as the 10yr neared 4% the demand at the following auctions was a pleasant surprise for fixed income markets. So it is again that, to whatever extent traders have protected themselves with any defensive selling leading up to this week, we could see a rapid release of pressure in MBS and Tsy's.
On the downside, to whatever extent auction results and FOMC confirm the downtrend we've experiences so far in August, we will have the unpleasant experience of finding out how much more markets want to adjust for a new interest-rate reality. The saving grace here is the nice poke above 99-00 we got today. Although the volume was so light that price movement doesn't really tell us much about short term sentiment today, simply beging above the long term floor of the range by 12 ticks allows us to fall at least that much before making serious assumptions about more prolonged weakness in MBS. In other words, we get to wait at least until the 3 year auction before making any fundamental changes to the hedge-ratios we apply to our pipelines.
All that said, we should all be aware that a fundamental price weakness is more likely to pervade MBS until the markets--with stocks as their guide--accept some form of correction before continuing in the recently discovered spirit of recovery. It's unlikely that we'll see any meaningful or prolonged push back into the 4's without a discernable period of weakness in the economic outlook, but that isn't necessarily a bad thing. primary/secondary spreads are still so wide, and so much uncertainty is priced into the market that Tsy's could level off for a period of sort of "stagnant optimism" in the 4.0% range, and mortgages could be going out the door in the low 5's until the next shoe drops.
Whatever the case, at this particular point in economic history, it wouldn't be wise to bet against the recovery momentum. But since a certain measure of "uncertainty premium" can now begin to fade away, the more pressing (and profitable) exercise would be determining how rates are positioned to line up with the PACE of recovery. Bottom line, don't doubt whether or not we are in recovery mode, but rather assess the pace, and what that means for your pipeline. After the turning point (or confirmation of a previous turning point) marked by last week's NFP, our first major chance to assess the pace and stability of fixed income's fade from prominence will be coming up tomorrow. Since a good deal of "fade" is already priced in, surprises for the better will still help us as always. And you'll still get your first and most thorough commentary on the MBS market's reaction to tomorrow's auction right here shortly after 1pm, as always.
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