All components of the Consumer Sentiment report were stronger than expected, with the headline index rising to it's highest levels since July 2007. Treasuries are 1 bps higher since the data at 1.921 and MBS are down a tick few ticks to 102-29. So far the weakness has been more contained than we'd expect given the magnitude of the beat, but it's too soon to assume this will continue to be the case. Early lenders will face reprice risk if we fall 2 more ticks, and even now, the trajectory of trading could be a concern for the edgiest lenders.

Bottom line: definitely some resilience here, relative the the data, but not without a slight increase in risk. We might squeak by with no reprices, but too soon to be sure.

There wasn't much to write home about in the overnight session. Treasuries traded flat to start and then rallied lower in yield during European hours thanks to stimulus hopes. The ECB is rumored to be consulting banking system participants on the practical effects of a negative deposit rate and several ECB governors were out this morning with varying levels of accommodative hints.

Despite the moderate drift lower in yield, 6:30am saw a bounce at 1.86% for 10's and we've been trending into weaker territory ever since. Factoring out overnight gyrations, charts look like they're simply extending yesterday afternoon's trends. MBS opened right in line with y'day's closing levels and are 5 ticks weaker currently at 102-31. 10's are up 2.5bps at 1.9036.

These are probably the most neutral levels of the week on both sides of the market. Despite the "aw shucks" initial reaction to seeing red on the screens in the morning, if it doesn't extend much past here, it would be a logical and necessary step in the "range-finding" that we're looking for ahead of next week's FOMC Minutes. This could be further confirmed by a near-consensus Consumer Sentiment print (or thrown off by a big beat/miss). 25 minutes to go until that one. Forecast calls for an increase to 78.0 from 76.4 previously

MBS had been losing touch with their memories of better times, when they were better able to keep pace with movements in broader bond markets and even outperform them into the beginning of May. Since then, the lower the coupon, the worse the underperformance. This is typical of a negative trend, and it typically turns around when the negative trend ends.

Additionally, lower coupon MBS tend to get a bit panicked if it looks like there's a risk they'll be "left on the island," in a rising interest rate environment. Particularly in 2013, any time 10yr Treasuries make a run toward or over the 2.0% level, this "fear" has been evident in lower MBS coupons (i.e. they lose a lot more ground than higher coupons, and by wider margins than those seen during sell-offs that occurred when benchmark rates are lower).

So when we have days like today (especially when they follow days like yesterday), where 10's are backing down from a run at 2.0%, we can then have afternoons like this one where MBS are making just a bit more progress than benchmarks. It's not a sign of MBS doing anything crazy or unsustainable, but rather a logical result of the supportive bounce in broader markets. It can continue as long as Treasuries don't drive the boat away from our island (head back up over 1.9).

It's like breathing a sigh of relief, and unwinding some of the previous tension. This has been evident not only in the price gains, but also in the speed with which lenders repriced positively today. Ongoing stability keeps positive reprice potential on the table for the rest of the day. Fannie 3.0s are up 20 ticks at 103-10 and 10's are down 7.47 bps at 1.865.

Overnight Treasury trading was some of the least eventful of the week with 10's almost perfectly flat during Asian hours. Some weakness crept in to the European session, heading into domestic hours, but never enough to challenge yesterday's high yields.

MBS opened in line with yesterday's close and soon moved quickly higher after all three of the 8:30am economic reports were bond-market-friendly. The gains quickly took Fannie 3.0s to yesterday's highs at 102-28+, where they struggled for nearly half an hour. Over the past 10 minutes, we're seeing them move higher, currently up to 103-31+.

The test of the technical ceiling in MBS coincides with a similar test of an important short term floor in 10yr yields (set by the lows on Monday and Tuesday at 1.893 and 1.895). 10's haven't moved through the floor yet, but did notch down to test it, briefly hitting 1.895. They've since bounced back to 1.90.

All things being equal, it would be nicer to be moving through that floor in 10's, but after 9 days of pain for bond markets, we'll take "possibility" over "pain." Philly Fed data is yet to come at 10am and if it's aligned with the rest of the morning data, we could see a more concerted effort to get to the other side of technicals. Unless that happens, this morning's relative victory may prove to be a bit hollow, especially if it ultimately reinforces the week's floor in yields.

- Housing Starts -16.5 pct vs +5.4 previously
- Unit rate of 853k vs 973k Consensus
- Permits 1.017 mln vs 945k consensus
- Single Fam starts -2.1 pct, Multi -38.9 pct

Privately-owned housing units authorized by building permits in April were at a seasonally adjusted annual rate of 1,017,000. This is 14.3 percent (±1.0%) above the revised March rate of 890,000 and is 35.8 percent (±1.3%) above the April 2012 estimate of 749,000. Single-family authorizations in April were at a rate of 617,000; this is 3.0 percent (±0.9%) above the revised March figure of 599,000. Authorizations of units in buildings with five units or more were at a rate of 374,000 in April.

Privately-owned housing starts in April were at a seasonally adjusted annual rate of 853,000. This is 16.5 percent (±5.2%) below the revised March estimate of 1,021,000, but is 13.1 percent (±5.1%) above the April 2012 rate of 754,000. Single-family housing starts in April were at a rate of 610,000; this is 2.1 percent (±4.8%)* below the revised March figure of 623,000. The April rate for units in buildings with five units or more was 234,000.

Privately-owned housing completions in April were at a seasonally adjusted annual rate of 689,000. This is 14.3 percent (±11.2%) below the revised March estimate of 804,000, but is 3.3 percent (±11.9%)* above the April 2012 rate of 667,000. Single-family housing completions in April were at a rate of 536,000; this is 9.8 percent (±10.2%)* below the revised March rate of 594,000. The April rate for units in buildings with five units or more was 149,000

Taking aim at the Fed's MBS buying program is nothing new for Richmond Fed's Lacker, but the current state of the housing market makes for a less tenuous arrow. Can such arrows shoot down well-armored, pro-MBS doves on the voting rotation? Not likely, but to whatever extent the housing recovery becomes bona fide, the argument gains traction.

The X-factor for Lacker could be the ambition on the part of servicers sitting on shadow inventory, gladly watching values and demand rise. Otherwise, the digestion of that inventory would likely whittle this new arrow down to match the ballistic potency of Lacker's typical anti-MBS projectiles, and those have all bounced off.

Here's the Reuters's original coverage of the speech: (Reuters) - An improving U.S. housing market suggests it is time for the Federal Reserve to stop aiming its stimulus at the real estate sector, Richmond Fed President Jeffrey Lacker said on Wednesday.

"When you look at housing market conditions, I think you could make the case that we should be getting out of mortgage-backed securities," Lacker told reporters after a speech.

Lacker, an inflation hawk who has consistently opposed mortgage-backed securities purchases by the central bank, said the process of getting out of the market could be initiated by reinvesting the principal from maturing mortgage bonds into the Treasury market.

- Headline Index at 44 vs 43 forecast and 41 previously
- Current Single Fam sale index 48 vs 44 previously
- Prospective Buyers Index 33 vs 30 previously
- 6 mo outlook index 53 vs 52 previously

- Market Reaction: Not much of a reaction, if any, in bond markets. a correction off the highs of the day was already in the works, but even that has been muted so far. Stocks are slightly higher.

From the NAHB:
Builder confidence in the market for newly built, single-family homes improved three points to a 44 reading on the National Association of Home Builders/Wells Fargo Housing Market Index (HMI) for May, released today. This gain, from a downwardly revised 41 in April, reflected improvement in all three index components – current sales conditions, sales expectations and traffic of prospective buyers.

“Builders are noting an increased sense of urgency among potential buyers as a result of thinning inventories of homes for sale, continuing affordable mortgage rates and strengthening local economies,” noted National Association of Home Builders (NAHB) Chairman Rick Judson, a home builder from Charlotte, N.C. “This is definitely an encouraging sign even amidst rising challenges with regard to the cost and availability of building materials, lots and labor.”

“While industry supply chains will take time to re-establish themselves following recession-related cutbacks, builders’ views of current sales conditions have improved and expectations for the future remain quite strong as consumers head back to the market in force,” said NAHB Chief Economist David Crowe.