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MBS Day Ahead: Wide Variety of Potential Motivations and a Retracement Primer
Posted to: MBS Commentary
Wednesday, April 16, 2014 9:23 AM

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With the resurgence of geopolitical risk as a market mover yesterday (Ukraine headlines caused a big mid-day bond rally), there will be a wide variety of potential inspiration for the next move.  On the list are:

  1. Economic Data
  2. Fed Speakers
  3. Fed Data (Beige Book)
  4. Technical Trading
  5. Headline Risk (more Ukraine?)
  6. Calendar effect (today is the last full day of the week)

As far as the economic data is concerned, today's offerings are 2nd tier when compared to the likes of NFP and ISM data, but can certainly move markets.  These include Housing Starts at 830am and Industrial Production at 915am.  Housing starts fell back to 'plateau' levels in the last two reports, but are now forecast to shake off the ostensible weather-related distortions and move back toward an annualized pace of 1 million units.

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Fed speakers dot the calendar throughout the day with speeches at 830am (Stein), 12:15pm (Yellen) and 1:25pm (Fisher).  Then at 2pm, the Beige book will be released.  That's hardly ever a market mover, but if Yellen takes questions, her podium time definitely could be.

The technical landscape provides a backdrop against which the rest of the potential market movers can read their lines.  One framework we keep coming back to is that of Fibonacci Retracements.  There's no magic here, and retracement levels don't really mean anything in any amazing "if/then" kind of way, but they are something that markets participants can easily assume other market participants are aware of.  Retracement levels are like the community cards in a poker game.

The underlying principles behind retracements vary depending on who you ask.  In general, it's probably safest to conclude the following (not only for retracements, but for any technical framework):

If trading levels have been adhering to a certain trend with relative regularity, when they cease adhering to that trend, it is significant.

The word "significant" in the above definition is intentionally broad.  It could mean anything from increasing volatility to a total reversal in the prevailing trend.  And as always, when it comes to technical analysis, significant signals don't always turn out to be significant.

Here are the retracement levels in 10yr yields mentioned above.  Keep in mind that the focus continues to be on 10yr yields as the best test subject to gauge bond market momentum that's relevant to production MBS (the coupons most relevant to rate sheets).  We can apply technical frameworks to MBS, but we'll get more reliable results by using Treasuries combined with an eye on MBS vs Treasury performance.  Ultimately, MBS prices' highest and best use is as an intraday reprice risk indicator.  They're rather lousy at speaking to longer term trends, whereas 10yr yields are very much up to that task.

Case in point, the two weakest episodes in the chart below end up being very close to the 3% level in 10yr yields whereas Fannie 4.0 prices were over 100bps off.  Throughout the time covered in this chart, MBS have been giving alternating signals with competing positive and negative trends.  Treasuries meanwhile have accurately captured the sideways slide in place since February. 

Note: retacement levels are derived from two recent extremes.  In this chart #1 is the first major high at 3.01% and #2 is the subsequent major low at 2.47%.  From there, the retracement levels simply measure how much of that move (from 1 to 2) has been undone or "retraced."  Some market participants looks for trading levels to experience more bounces at retracement levels while others just expect that significant breaks of a retracement level will result in follow through to the next level.

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Obviously 2.60 has provided tough resistance.  The only significant break came courtesy of government shutdown-related volatility.  The risk is that yields continue failing to break lower, in which case 2.68 is implied as the next consideration.  A significant break of 2.60 (say, mid 2.5's) however, would open the door for another run to 2.47.  Anything between 2.6 and 2.8 is simply 'more of the same.'

MBS Pricing Snapshot
Pricing shown below is delayed, please note the timestamp at the bottom. Real time pricing is available via MBS Live.
FNMA 3.0
97-02 : -0-06
FNMA 3.5
101-04 : -0-06
FNMA 4.0
104-11 : -0-05
2 YR
0.3750 : +0.0040
10 YR
2.6589 : +0.0309
30 YR
3.4943 : +0.0343
Pricing as of 4/16/14 9:23AMEST

Tomorrow's Economic Calendar
Time Event Period Forecast Prior
Wednesday, Apr 16
7:00 Mortgage Market Index w/e 351.0
8:30 Housing starts number mm (ml)* Mar 0.973 0.907
8:30 Building permits: number (ml)* Mar 1.008 1.014
9:15 Industrial output mm (%) Mar 0.5 0.6
9:15 Capacity utilization mm (%) Mar 78.7 78.4

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Recent Housing Data:
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  • Refinance Index 11.33%
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  • Purchase Index 8.43%