It was a bad week.

There were moments of hope, but for the most part we watched helplessly as the market moved in the wrong direction. And today. Ugh. Today was the icing on the cake.  It was absolutely abysmal!!! But believe it or not, what happened today in the bond market was actually good for us. We needed this.  I know that seems impossible but hear me out...

We've just witnessed a perfect example of "Buy the Rumor, Sell the News".


October 15, 2010: Mortgage Rates: Play the Range Until Bernanke Plays You

Plain and Simple: Energized, Exuberance, Over-Exuberance, Exhaustion

Energized: Another Federal Reserve "Quantitative Easing" (QE) program

Exuberance: Think of "QE" as a strategy employed by the Federal Reserve to force the economy into a sustained recovery. This strategy might include large scale open market purchases of Treasury debt or MBS (Bernanke has indicated MBS purchases were possible). If that scenario played out, it would be very supportive of  mortgage rates touching 3.75% again.

Over-Exuberance:  Too many investors piled onto the same side of the bond market. When investors learned the Federal Reserve was seriously considering the idea of another QE program, they upped the ante by purchasing more government bonds, which pushed Treasury prices higher and higher and Treasury yields lower and lower. This is what led mortgage rates to new record lows last Friday.

Exhaustion: Mortgage rates touched new lows and bond prices touched local highs last Friday, but when the market came back from a long holiday weekend on Tuesday, investors wanted more details on the next QE program. Without further details, the bond rally stalled and the trading environment turned stale. We had three ugly Treasury auctions with the ugliest of all on Thursday. That was the straw that broke the camel's back. Lender repriced for worse late yesterday.

Well it seems that over-exuberance wasn't quite washed out yet. (Don't miss this: the above excerpt was written on October 15th).

The market fought hard all week to overcome it,  but the pain trade finally prevailed and the QEII "sugar high" came totally undone. Frustrated longs were forced to liquidate.   The reset button was hit  and funds were freed from weeks of imprisonment (near important technical levels).

This is a good thing.  It creates more balance in the marketplace. It levels of the number of buyers and sellers. It was a cleansing. The bond market is now free to focus its strategies on the QEII purchasing schedule of the Federal Reserve

PLAIN AND SIMPLE: The Fed will conduct 17 open market asset purchases over the next 18 trading sessions. They will spend about $105 billion which works out to around $5.8 billion per operation. 9 of those operations will have a direct influence over "rate sheet influential" MBS coupons (red), with at least $45 billion allocated toward the belly of the curve. If you add in purchases that include the 5yr sector (green), which is a benchmark for many MBS hedgers, this total rises to 12 of the 18 operations and at least $63 billion with a max potential for $84 billion focused on our rate sheet influential benchmarks. This is great news for mortgage rates.

It's an unsettling feeling, but I am not panicking. It's a waiting game and I get the feeling what we saw today went a long way in keeping the range in play.

It's always darkest just before dawn.

RIP Grandma