MBS LUNCH: Where Did the Rates Rally Go?

by Adam Quinones

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NFP dust has settled, let's check on the markets...

The  immediate trader reaction to weak jobs data pushed the 10yr note yield from 3.18% all the way down to 3.10%. The precipitous fall in benchmark yields helped the FN 4.0 hit an intraday high of 100-09+ while the FN 4.5 topped out at 102-07. However as the trading session has progressed, TSY yields have risen back towards yesterday's 5pm "WOW TSYS RALLIED HARD TODAY" marks and rate sheet influential MBS coupons have given back all their post-data price appreciations.

Currently the 10 yr is -0-10 at 103-16+ yielding 3.21%....within yesterday afternoon's price range, the "dont panic" range.

After crossing over 100-00 for the first time since "the good 'ol days" (PRE-BLACK WEDNESDAY), the FN 4.0 is currently -0-04 at 99-20 yielding 4.0451%. The FN 4.5 is -0-02 at 101-23 yielding 4.2927%....15 ticks (13/32) lower than intraday high price of 102-07...

Below is the FN 4.5 two day. After spiking higher following the NFP print, the FN 4.5 has found its way back to familiar territory...close to YESTERDAYS price highs.

Why have TSY and MBS price rallies failed to continue after the weak read on the labor market?

From Vic's commentary on Mortgage Rate Watch:

"Mortgage rates moved a few basis points lower yesterday after the  bond market experienced what AQ and MG refer to as a "forced rally". Stocks were selling the dollar was stronger and the market was generally nervous about a weak Jobs report after Goldman Sachs revised their Non Farm Payrolls forecast for the worse. This equation resulted in a heavy flight to safety rally in the fixed income market which essentially snowballed as market participants looked to keep up with rapidly appreciating prices. As a result, mortgage backed securities prices closed at levels not seen since May.  Following the rally in Treasury and MBS markets, lenders republished rate sheets for the better and consumer borrowing costs fell."

Plain and Simple: worse than expected data was baked into the market yesterday...this morning's NFP print didnt surprise anyone, weak fundamentals were already priced in

We pointed out "dont panic" ranges and status quo price levels in the charts above for good reason...because we wanted to illustrate that while the rally has failed to extend...THE RANGE BREAKOUT IS STILL INTACT. Yesterday's progress has not been lost!

THEN WHY ARE LENDERS REPRICING FOR THE WORSE?

Because many lenders published rate sheets after the initial post-data price spike...and prices are now well off those intraday highs...REPRICES FOR THE WORSE ARE OCCURRING.

But today's reprices for the worse are more akin to a "fine tuning" dial on a radio.  The more significant movements come courtesy of the big dial, turned this week by the expectation and reality of jobs data.  So despite the minor course correction today, the net effect is a 20 tick gain on the week from already high levels.  More importantly, this AM's data confirms, validates, solidifies, supports, and cements shifts in yield curve and MBS pricing that would otherwise have seemed downright scary. 

NOW WHAT? HOW LONG WILL THE RANGE BREAKOUT LAST? How do we trade the TSY market now?

There are some huge competing currents now.  On the one side we have everything discussed above.  On the other side, there are weeks and weeks of seemingly invincible stock gains that have acted in spite of data (dare we say, sometimes even logic?) in addition to an unprecedented October TSY supply.  It's fear vs. hope compounded by the moving-target sentiment of stock traders.  It's the paradigm shift vs. "more of the same."  It's time to zoom out to 50k feet and take a look at the BIG PICTURE...

HAS GOVERNMENT STIMULUS, FED QUANTITATIVE EASING, COMPANY COST CUTTING, TRADING REVENUE SUPPORTED BANK PROFITS, ETC ETC ETC REALLY STABILIZED THE ECONOMY AND HELPED JUMPSTART GROWTH?

or

HAS GOVERNMENT STIMULUS, FED QUANTITATIVE EASING, COMPANY COST CUTTING, TRADING REVENUE SUPPORTED BANK PROFITS, ETC, ETC, ETC ONLY SERVED TO DELAY THE INEVITABLE DOUBLE DIP?

SOAPBOX MOMENT: Oh and if you believe housing has really turned up and a recovery is in the works...think again. We will continue to state that tighter lending guidelines combined with high rates of unemployment and a generally less wealthy/less creditworthy consumer base will keep housing inventory high for years to come...regardless of low mortgage rates. (YES, we think prepay speeds will continue to be on the slow side of expectations).

Are we indeed  in the midst of a paradigm shift?  The beginnings of another economic downturn?...OR....Will "better than expected" econ data help stocks continue rallying and therefore provide more reason to believe that a stabilization has and will continue to occur?

We are getting glimpse at the "good 'ol days" right now...mortgage rates are holding near record lows. However, at this point, if traders are to push yields even lower (less returns)...they will need CONFIRMATION that the stabilization has been artificial and thus vulnerable to another downturn...until economic data and market events provide more reason to doubt the extent of the "stabilization"...TSY traders will be happy to focus on SHORT TERM stragtegies that revolve around auction concessions and the shape of the  yield curve.

PLAIN AND SIMPLE: The "potential" paradigm shift would need to be confirmed as an "utterly irrefutable" paradigm shift if the bond market is to continue to rally. In the mean time traders will gladly continue to implement short term strategies to churn the market for profits.

That said, while next week's auctions are expected to benefit from a generally nervous economic environment, the short term trading tactics being employed by traders to "make room" for TSY debt supply sway our outlook to favor locking vs. floating.