On June 5th, before the most recent ADP report, and with an eye toward NFP on the upcoming Friday, I laid out the reasons that we should not expect the Fed to care about the mortgage environment in the wake of taper talk, saying that Bernanke isn't likely to ride to the rescue on his MBS Stallion.  Here's the post, but I'll break out the relevant points below as well, beginning with the example of the logical but faulty thinking and some highlights added for emphasis:

"MBS markets are bleeding on the sidewalk, remember?  Won't that cripple the fledgling recovery?  The Fed has ridden to the rescue of MBS before and they'll do it again by golly!"

This line of thinking is, in fact, quite logical; the questions, fair.  But there's a huge immediate problem with it: the Fed doesn't have a history of that sort of critical thinking when it comes to MBS.  Add the "boom" claims, ostensible market happiness, and exit disruption fears to the mix, and we can be relatively assured that we won't soon be hearing the thundering hooves of Bernanke's MBS stallion. 

While that horse isn't out to pasture yet, it's been predictably stabled given the current state of affairs, and it helps make the point about the Fed's critical thinking.  The following chart contains spreads of MBS YIELDS vs 10yr yields and the white circles show the instances where the Fed has announced NEW MBS buying (not the extension of pre-existing buying).  The white circles might as well be Ben's white stallion, and as you can see, we're not quite into the previous danger zones that sent him running for the stable.

Bottom line, the Fed is, and will continue to be, 'OK' with the current pace of MBS widening and the current pace of the rising rate environment.  In fact, they'd be delighted if the 400 point drop in Fannie 3.0 prices since May 3rd didn't have a significant impact on employment or prices.  One thing's for sure though, until/unless it does, or until the underperformance of MBS gets much, MUCH worse than it has been in the past month (thinking about the little teal line at 0.83 getting up over 1.04 in the chart above), don't expect any heroics from the Fed.  The current spread situation is like the proverbial 'stick' when it comes to motivating Bernanke MBS Stallion--a beast that has a 100% track record of preferring the 'carrot' offered by truly disconcerting spread blow-outs (see the white circles).

That assessment turns out to have been borderline prophetic.  Not only did Bernanke characterize the rising interest rate environment as a "good thing," but he spoke specifically about spreads as well. 

Near the end of the press conference he was asked a question in the similar vein as the "faulty logic" question in the example above.  Surely, Ben wouldn't say anything to add more fuel to the fire.  Even if I was right about the spread thresholds, he wouldn't actually say that would he?  Quite the opposite, sadly:

"our assessment is that the MBS market is still a very healthy market in terms of spreads"

If looking at that chart on June 5th wasn't enough to convince you that the Fed is clearly focused on MBS spreads as a benchmark for adding accommodation to MBS markets, Bernanke just confirmed it. Now at least we have a rough idea of how much more we'd need to bleed before the Fed would care again.

Conclusion: More MBS pain at the moment. Treasuries are certainly participating in the sell-off as well, but MBS would be bouncing back on spread if Bernanke hadn't confirmed our nauseating suspicion. Fannie 3.5s at 102-14. 10yr yields still pushing 2.32.