Posted
Recap of Yesterday...
- ADP Employment Report: -203,000 jobs in October vs. revised for better -277,000 cuts in September. October read better than expected.
- Treasury Refunding Announcment: $81bn in TSY supply next week. $40bn 3yr notes, $25bn 10s, and $16bn 30s. 10yr note sales $1bn more than expected..TSY extending duration of portfolio
- Bankruptcy filings +8.9% in September vs. +4.1% in August. +27.9% year over year
- FOMC makes a few changes to statement, does not alter verbiage "for an extended period". I wrote lengthy discussion on what the text is telling us and how it relates to mortgage rates. READ MORE
- Senate Passes Homebuyer Tax Credit Extension 98-0. Goes to House for vote. READ MORE
- FHA delayes the release of their internal audit...says inaccuracies in study's econometric model. READ MORE
The FN 4.0 ended the day +0-01 at 98-06 yielding 4.187%. The FN 4.5 went out the door +0-02 at 100-28 yielding 4.395%. The secondary market current coupon was 4.343%. The Current Coupon yield was +82/10yr TSY and +65/10yr swap. Tighter on the day but wider than 3pm marks. Yield spreads tightened considerably (MBS yields rose less than their benchmarks) as demand greatly outnumbered supply (3 to 1).
The old news was NO SUPPLY as lenders continue to originate only marginal amounts of new production. The NEW news yesterday was demand. This reflects a "wait and see" MBS attitude leading into the FOMC statement and a "WHO HAS SUPPLY I NEED IT" after the FOMC statement.
So Far this Morning....
- SHANGHAI +0.85%, HANG SENG -0.63%, TOPIC -0.72%, NIKKEI -1.29%, CAC +0.34%, DAX +0.29%, FTSE +0.20%
- ECBs makes no change to rates policy. READ MORE
- Bank of England announces NO CHANGE to rates policy, but increases asset purchase program by 25 billion (read as US$40bn) to 200 billion. Reminder: we are winding down our asset purchase programs (for now) READ MORE
- US ECON DATA: 3Q Productivity +9.5%. Labor Costs -5.2%. Good for inflation expectations.
- US ECON DATA: Jobless Claims down to 512,000 from 526,750 last week. Better than consensus expectation of 523,000
After the data, the dollar index weakened, oil prices barely budged, same with Goooooooooollld, and S&P futures ticked higher after the data....currently at 1,053.I posted an interesting column in Around the Web called 'The Best Trader in the World is Wildly Bullish on Gold'.
In the rates market, the 2yr note is +0-01 at 100-07 yielding 0.889%. The 10yr note is -0-07 at 100-21 yielding 3.543%....not making much progress from yesterday.
The FN 4.0 is trading +0-00 at 98-06 4.187% and the FN 4.5 IS +0-00 at 100-26 yielding 4.395%. The secondary market current coupon is 4.343%. Rate sheets should be essentially unchanged from yesterday.
The yield curve underwent a massive steepener yesterday...meaning yields in the short end of the curve (2s) outperformed yields in the long end of the curve. After the FOMC statement the 2yr note yield fell from 0.952% down to 0.904%. On the other end of the curve, the 10yr note yield actually rose as high as 3.559% before calming and returning to the pre-FOMC range between 3.50 and 3.52%. The 2s/10s portion of the yield curve ended the day at 260bps.
Its all about the steepness of the curve right now. This chart should put that steep spread into context...275bps is the record. We currently are holding near 260. This means there is room for the curve to continue to steepen...this means there is room for rates to continue to rise.
The logic behind the steep yield curve is a function of two separate events. The first event being the FOMC meeting, the second being Non-Farm payrolls and the market's pre-data positioning.
1. The FOMC statement was a big deal for the front end of the curve. If the Fed implied they were considering a rate hike, the 2yr note would have sold off FAST. This is because the market is heavily positioned in a carry trade in the short side of the curve. To keep it simple, I will describe the carry trade as follows: accounts who can invest in size (large positions) can borrow money for almost nothing (Fed Funds), then they lend it to the government via Treasury debt purchases (2yr note). This 'borrowing short and lending long'. If the FOMC hinted at or raised the Fed Funds rate (repo rate) yesterday, then the 'carry trade' would turn negative and the yield curve would flatten as yields in the front end of the curve rose more than yields in the long end of the curve.
Basically if the Fed decided to raise rates or implied they were going to raise rates...all the accounts who were invested in 2yr notes would RAPIDLY exit those positions. This would bear flatten the yield curve and make room for the long end of the yield curve to sell off as traders wait for the spread between 2yr notes and 10yr notes to widen up again...at least until it was as profitable to 'borrow short and lend long'. Unforunately this would result in higher mortgage rates.
I got a little carried away there (haha PUN intended)...besides the curve trade explanation, my point is as follows: Because the Fed did not change the verbiage "for an extended period"...2yr notes rallied.
2. While 2yr note yields fell, the long end of the yield curve was not so fortunate. Leading into the FOMC statement, 10yr yields were trading over 3.50% support. After the statement, the 10yr yield rose to 3.559% before falling back down to 3.52% later in the session. Over the past few months, as you can see in the chart above, when the 2s/10s curve reached a spread between 250 and 260 basis points...traders considered the yield curve cheap, and placed trades that helped the curve bull flatten...aka 10yr notes outperformed 2yr notes....aka they sold 2s to buy 10s. This did not happen yesterday...instead, even as 2yr note yields fell and the 2s/10s curve continued to steepen towards 260bps, there was no buying interest. Hmmm....why?
SELL THE RUMOR, BUY THE NEWS is a simple way to describe it. Perhaps the bond market priced in a better than expected NFP report? Or maybe the market is starting to get worried about inflation? After all the dollar is WEAK and demand for gold is rising, plus one of the changes the FOMC made to the statement could be considered a means of covering their back in the event inflation really does become an issue. READ MORE.
Making matters worse was yesterday's Treasury refunding statement...while the debt supply was pretty much as expected...the Treasury is lengthening the maturity of their portfolio...this means they will shift the weight of their issuances towards longer life debt...like 10yr notes. More supply in the long end of the curve is a reason to let yields rise a bit higher too. Anything else? Hmmm....how about no more Fed Treasury purchase program? That should be considered as well. Or this is just the evolution of the short term trading environment...last Friday rates rallied, that trade base was taken out (unwound) on Tuesday and short positions were placed. Once the majority of the market was SHORT the long of the yield curve, they had less incentive to buy because it went against their current position. So now traders will let yields rise until given a reason to head the other direction. Helllloooooo range trade!
My point: while the short end of the yield curve had reason to rally (no rate hike), the long end of the curve had no real reason to be bought yesterday. Wait and see mode until tomorrow morning at 830 when NFP prints. Although "rate sheet influential" MBS coupons have held up well (holy tightener) as benchmark TSYs have NOT held up so well....it would be nice to see some speculative/corrective flattening ahead of NFP. Wait and see....I would be anticipating at flattener at some point, but would definitly hedge my position either way.
This is getting complicated, but its what matters most right now! Ask questions if something is unclear. We will do our best to answer them all. Also, MG wrote a Plain and Simple on the topic: READ MORE ON THE SHAPE OF THE YIELD CURVE
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