MBS OPEN: Yield Curve Flatter. Rate Sheet Influential Prices Higher

by Adam Quinones

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Recap of Last Week

• Senior Loan Officer Survey indicates credit conditions still tightening. DU 8.0 will continue to contract credit availability in the mortgage market
• Home buyer tax credit resources HERE
• FHA Audit reveals FHA reserves at all time low READ MORE
• Fed Purchases $13.5 billion agency MBS. Slowing pace of purchases still yet to affect MBS valuations
• Purchase Mortgage Applications at 9 year low. Refinance apps +11.3%. MND Story
• JP Morgan Chase hiring originators. READ MORE
• Senator Dodd Proposes Financial Reform. Section 1503 encourages transparency in asset securitzation. Tall task for mortgage market to accomplish...READ Brian Montgomery's comments
• BEWARE: GSEs Strictly Enforcing Loan Buyback rules. Lender's must have skin in the game. Tim Rood discusses
• Wells Fargo reducing borrower payments to help struggling borrowers. READ MORE
• 2010 Loan Limits Announced. Temporary "high cost" loan amounts extended. MND STORY

While data and events do indeed serve as a catalyst for rates directionality, the market's long term bias remains clouded by a great amount of economic uncertainty. This forces the market to focus on trade flow dynamics and supply and demand fundamentals:

Plain and Simple:  The major mover of money in the markets continues to be the moving of money itself.

Last week, $40 billion 3s, $25 billion 10s, and $16 billion 30s were the obvious guidance giver in the rates market. With the Fed's withdrawal from the Treasury market complete, the Treasury reminding of their intentions to lengthen the duration of their debt portfolio, and the market confident in the Fed's decision to remain accommodative for an "extended period" ...the obvious profit churning trade was to let the yield curve steepen.

This move started after the FOMC statement was released on November 4 and carried all the way through the 30yr bond auction last week. The "steepener" trade did however start to unravel following the duration heavy auction cycle. The life of the recent "steepner" trade is apparent in the 2s/10s chart below. Notice how yield spreads began to tighten late last week after short covering profits were booked in the long end of the yield curve. Wider yield curve spreads = steeper yield curve. READ MORE on the shape of the yield curve and yield spreads

Generally when the long end of the yield curve sells off (bear steepens), rate sheet influential MBS coupons suffer and mortgage rates increase. However, this has not been the case in the TBA MBS market lately. A lack of new loan production combined with ongoing official support (the Fed), call out nervousness (prepayment risk),  and the Class A settlement process helped spark a massive tigthener in the agency MBS market.

Plain and Simple: Rate sheet influential yields have been greatly outperforming those of their benchmark's....even as the long end of the yield curve sold off and benchmark rates moved higher (yield curve steepened). You can thank the Federal Reserve for keeping mortgage rates stable over the past two weeks. I should also add that I have been receiving a larger than normal amount of consumer "lock/float" inquiries lately...I advised locking.

Here is a look at my spreadsheet...

I waited until the end of the week to give the 4.0 coupon a little extra weight...by Friday afternoon the secondary market current coupon had fallen to 4.169% and  "rate sheet influential" yield spreads were at their tightest levels since May.  If my spreadsheet is not spatial enough for you, below is a chart of the FN 4.5 with 10yr yields overlaid...

I dont usually overlay benchmark YIELDS on mortgage PRICES, but I think the inverse relationship, or lack thereof in early November, is demonstrated clearly enough to warrant the comparison. Notice how MBS prices and 10yr yields generally move in opposite directions? This wasnt the case in early November...check out how MBS prices continued to rise even as 10yr yields moved higher. This shows you how MBS supply/demand dynamics sheltered mortgages from the steepening yield curve bias that was moderating the strength of benchmark big brothers (guidance giver). Perhaps the best way to say it is...we disconnected from the benchmark lever?

The Week Ahead is busy, lots of data and Fed speakers. READ THE MND WEEK AHEAD for more. The trade tactic we anticipate to be a rates money mover...the unwinding of the yield curve STEEPENER trade. We expect the long end of the yield curve to recover from the beating it has taken over the past two weeks and for MBS/TSY yield spreads to widen up as the long end of the curve outperforms "rate sheet influential" MBS coupons.

Plain and Simple: MBS profit taking is looming, but if the yield curve flattens out, mortgage rates may still hold steady near current levels.

Since its getting kinda late for the OPEN, I will continue this conversation later in the morning.

The long end of the curve and 10yr TSY note have been bid well so far this morning. Currently, yielding 3.395%. The FN 4.0 is +0-06 at 99-11 yielding 4.072% and the FN 4.5 is trading +0-01 at 101-25 yielding 4.283%. The secondary market current coupon is 4.146%.