MBS OPEN: Previous Positions and FOMC Keep Rates in Range

by Adam Quinones

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Recap of Yesterday...

• Manufacturing and Pending Home Sales both better than expected.
• Pending Home Sales +6.1%. NAR Chief Economist points towards FTHB Tax Credit as catalyst
• ISM Manufacturing led higher by Production and Employment. Look for temporary increases in employment while demand side of output function recovers
• The US Treasury will borrow $276 billion in the fourth quarter ...much less than anticipated. Treasury expects to borrow $478billion in 1Q 2010
• Dollar weakend against a basket of currencies. Oil and Gold both more expensive, +1.45% to $78.12 and +1.33% to $1,058 respectively.
• In a choppy session stocks closed the day in the Green. The Dow led domestic equity indexes with a 0.79% gain to 9, 789, the S&P was +0.65% to 1,042. and the NASDAQ was +0.20% to 2,049
• The rates market suffered from better than expected econ data, but didnt move too far...the range contained price action. MG Elaborates
• The 2yr note ended the day at 0.921% and the 10yr TSY note ended the day at 3.418% (5pm marks). Interesting that the 2yr note is trading so aggressively ahead of the FOMC meeting...
• The yield curve steepened. 2s/10s at 250bps. 2s/5s flatter though...
• "Rate sheet influential" MBS dollar prices closed lower, yield spreads wider against benchmarks. FN 4.5 closed at 100-30+, slightly under our 101-00 pivot point
• Trading flows were slow, supply marginal...Fed buying and "UP IN COUPON" day trading as yield curve steepened.
• Mortgage rates holding in aggressive side of recent range. Didn't move much yesterday
• Phils delay Yankee's parade..force game six

So Far Today....

• SHANGHAI +1.22%, HANG SENG -1.76%, TOPIX -1.58%, NIKKEI -2.31%, CAC -1.82%, DAX -1.43%, FTSE -1.71%
• The Reserve Bank of Australia raised their cash rate by 0.25 to 3.50%
• RBS and Lloyds to recieve $51 billion in bailout funds. READ MORE
• UBS posts 3Q loss, Sees Outflows Persisting READ MORE
• EU raises GDP outlook READ MORE

S&P futures fell in the overnight session ....but have failed to make noteworthy progress in either direction ahead of the FOMC statement tomorrow. At the moment traders are testing a several technical levels. Price action has bounce around between the 23% retracement of the longer term trend cycle at 1,045 and several moving averages.

Yesterday, although econ data was not bond market friendly, the 10yr note held to its range. We think this is a function of Friday's rally and the overall shape of the yield curve.

1. On Friday volume accumulated as rates prices rallied....meaning volume steadily picked up into the move higher, implying many traders were adding positions as rates moved lower. The fact that volume picked up into the rally implies there is a level of support under the market near 3.45%...some positions were placed even deeper into the rally so there is a weaker level of support under 3.45% but over 3.42%. Yesterday, volume fizzled out as rates backed up...illustrating that many traders have an interest in pushing rates lower in the short term just to build profits on the position they set on Friday.

Plain and Simple: High Volume into the rally puts a level of support under market. Low volume into sell off indicates less traders participate in selling...less traders WANT prices to fall because it cuts down on their profit.

2. 2yr notes rallied down to 0.901 yesterday which steepened the 2s/10s curve up to 250bps. Ahead of the FOMC statement tomorrow we would expect to see the short end of the yield curve give back a few bps as traders speculate a shift in the Fed's verbiage on monetary policy...specifically the text that reads:

"The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period."

While we have made it very clear that we do not anticipate a change to above verbiage in the FOMC statement, we do respect the market's OPPORTUNISTIC bias to trade this speculative position. So...leading into the release of the FOMC statement we believe the 2yr note will give back a portion of its recent gains. Higher 2yr note yields and steady 10yr note yields means a flatter 2s/10s curve ahead of the FOMC statement. On the other hand, there is pressure on the yield curve to steepen ahead of tomorrow morning's Treasury Refunding announcement . Meaning the short end of the curve may sell off, but not as much as the long end. I guess we get to see how worried traders really are about a change to the FOMC statement text. FOMC Statement vs. Treasury Refunding Announcement.

Here is the 2s/10s curve...

Plain and Simple: we think the 10yr note is going to have major difficulty breaking through 3.38%, at the same time we anticipate rates will run higher after the FOMC meeting (maybe even before), however unless we see heavy profit taking volume, 3.45% support will  hold up and the 2s/10s curve will steepen up a few bps before bargain buyers step in to buy the curve. That means we are expecting rate sheet influential MBS coupons  to give back a portion of their price gains...which could result in less rate sheet rebate.

Anyway...

The FN 4.0 is trading +0-03 at 98-12 yielding 4.168%. The FN 4.5 is trading +0-03 at 101-01 yielding 4.375%. The secondary market current coupon is 4.292%.

Here is the FN 4.5 chart. 101-00 has "PARNERTIA" gravitational effects.