It's not so much that the past three days have been remarkably good for MBS prices, but rather that an extended period of relatively stable bullishness that began in August merely made it two ticks higher than previous. In other words, this isn't so much about something unique happening versus the last four months, but rather about recent data and events giving just a little extra boost to a very narrow range over the last four weeks. Indeed, when you see the daily chart further down the commentary, the rally over the last few days doesn't seem out of place at all in that context. But let's start with today's action:
As we saw in the AFTERNOON commentary, MBS were very actively gyrating in and around the two technically significant levels of 100-28 and 101-00. Indeed the close at 100-31 brings us to the highest end-of-day level in four months. But there are several caveats to that... First of all, we've topped 101-00 numerous times on an intraday basis only to close at 100-28 or below by the end of day. So there is not some mystical barrier that prevents prices from being higher than that, it's just that it usually holds up by the time the lights turn off. But of significantly higher importance would be the issue of validation and/or confirmation from the yield curve, or more appropriately the LACK thereof...
Does the chart above make sense considering the term "validation?"
PLAIN AND SIMPLE:
That MBS and the yield curve are inextricably linked should be second nature to us by now... On a slightly more complex level, I'd also hope that most of us understand what's been happening with MBS spreads since Uncle Ben and the gang got involved. If not, it's shown in plain detail on this chart from the article we recently put out. If you don't remember it or are want to revisit, just click the mini version of the chart at the bottom of the "plain and simple indentation to go to the article itself:
All that to confirm that we approach today's chart with the understanding of both the fact that MBS are generally correlated to treasuries, and the distance between their yields is about as close as it ever gets... We often refer to this as "tight" as opposed to "wide." The term for this is "yield spreads" or if you're focused exclusively on MBS, then simply saying "spread" would suffice.
Why is the understanding of those two concepts important to today's discussion on validation? Because IF MBS BREAK THEIR BEST LEVELS IN OVER FOUR MONTHS, IT WOULD BE MUCH MORE SIGNIFICANT IF TREASURIES WERE DOING THE SAME. But as you can see, they are barely in line with the best levels from last week, with 2 more lows before reaching a comparable price level to that achieved by MBS today.
Now, drawing on the SPREAD concept above, IF WE KNOW THAT SPREAD IS OPERATING NEAR IT'S ALL TIME TIGHTEST LEVELS, THEN THE LIKLIHOOD THAT IT WILL TIGHTEN FURTHER IS LOW. That being the case, the overall bond market would have to rally further in order for MBS to sustain this breakout. That's certainly not to say it couldn't happen, but simply that the real victory celebration for MBS closing over 100-28 will be when it does so with the best combination of the following conditions:
- Spreads show signs that they can move in either direction as opposed to "probably wider."
- the breakout is much more significant than a mere two ticks, preferably carrying us over the 101-00 mark.
- the breakout, if not significantly higher than 100-28, should then sustain itself for several days
In the absence of that "stuff," today's 100-31 is just a slight outlier WITHIN the trend that already existed. We really want the epic technical signals in MBS to coincide with epic technical signals in their benchmarks... That's pretty much it... Here's the promised thumbnail:
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Ok, so much for plain and simple! Back to the "complex and confusing!" So if you skipped the previous breakout session, we basically just said that although it's cool to be able to say "highest close in over four months," it doesn't mean nearly as much as it could had we had some sort of validation either from outright tsy levels or by a more extreme breakout that coincided with some fundamental REASON for spreads to move tighter (which would have to be pretty amazing to tighten further from all time tight ranges - something like "fed to buy 2 trillion MBS every year for the next 3 years." Hail Comrade!)
Caveats aside, it was a good Thursday. Especially pleasing--the kind of pleasure that can only be conveyed by leaning back in a full grain italian leather victorian nailhead office chair in one's diabolical lair while slowly pressing the tips of one's fingers together while making threats to British secret agents, smiling calmly and saying "excellent...."--is the fact that we had a good connection in the stock lever today. That "excellence" can be converted to something more emotional if stocks happen to beat their recent retracement record which stands at about 35 points over 2 days. But you know us, we're not even musing on a stock correction any more, except inasmuch as we have Pedro Cerano in our locker room right now trying to strongarm Jobu into selling his stakes in a couple blue chips...
The final chart to cast just a bit more light on where we really sit at the moment--10 yr futures:
This isn't some revelation of technical analysis. In fact, hourly movements in tsy futures often exhibit similar alignment of high volume marks and bullish hours on days where prices are advancing due to anticipated data. That's what we have going on above with the highest volume hour also being the biggest gainer after the FOMC announcement. It's very likely that volume would be nearly as high even if prices had stayed flat. But then the additional high volume hour this AM coincides with the positive reaction to morning events such as weaker housing data and perhaps most importantly stock's response to the data. It's not so much that this cements any sort of bullish support for bonds, but much much much more importantly to show that for once in this crazy period of chopitility that BOND GAINS OCCURRED ON VOLUME--thus suggesting the price improvements are not the product of artifical movement created by technical trading within a range. More simply, bonds gained for a REASON, and that was confirmed by the volume and by the selling in stocks.
But if there's one message to take away from tonight's closing commentary it's that we're STILL UNDER 101-00, and indeed haven't been above it since before black wednesday. That is the upper limit of the big picture range that sits in contrast to the golden days H109. Busting out the broken record player, we find: "The trend is your friend, until it's not." So yes, you might lock a few deals at these highs and then watch stocks sell off and bonds continue to gain, but if you wait to go float biased until there are more significant technical and fundamental reasons to do so, your chances of long term profitibility are probably a bit higher than if you let today's and yesterday's gains push your float boat out to see with too many crew members. Get me? Look for rates somewhere around the best levels you've seen since May and if you see 'em and lock a few floaters that have been with you a few days to a week or two, hard not to consider that some excellent and intelligent profit-taking.
Tomorrow is no Friday Data slouch! So be prepared for the unfamiliar experience of more fundamental connection between data and market movements. Coming off yesterday's FOMC, data is much more fashionable than it was before the announcement. Here's what we have:
- Durable Goods
- Consumer Sentiment
- New Home Sales
None of those are bottom-shelfers, even though none are truly top-shelf either. But given today's reaction to housing data, new home sales tomorrow are more important than normal tomorrow to whatever extent they deviate from the mean either better or worse. If they're better, they go a way towards refuting today's market response. If worse though, it's a one-two punch that could be just what the bond market needs to find a genuine second wind as opposed to the teaser that MBS gave us today at 100-31.
MBS Market Alerts
