Yesterday stocks found early morning optimism in better than
expected jobless claims data, but lost that warm and fuzzy feeling when reality
set in that Chrysler (and likely GM) would face Chapter 11 Bankruptcy. The Dow
hit an intraday high of 8305 but fell precipitously leading up to President
Obama's news conference announcing Chrysler would be unable to pay their debts
after creditors refused to renegotiate. The Dow closed at 8168...down 17.61
points on the day.
While equity traders were seeking reason for hopefulness,
the 10yr Treasury note yield hesitantly drifted back and forth between 3.10 and 3.17 as fixed
income market participants harbored their dissatisfied feelings with the FOMC's
lack of attention to the steepening yield curve. Most yield curve watchers were
anticipating the Fed would ramp up their open market Treasury purchase program,
so when there was no fixed income friendly verbiage in the FOMC statement....positions
needed adjusting and new strategies needed to be implemented. This put yield
chasers in a technically driven trading posture and created some market
movements that were not easily discerned by an untrained eye (or if you dont have all
the tools necessary to know what was moving money).
As stocks searched for economic bottom and the yield curve
steepened.....mortgage buyers were forced to face the music.
What Music?
The drone of the yield curve grinding steeper and the
screams of worried MBS buyers fleeing anything EXTENSION RISK related...
Since early April the 10 yr Treasury yield has risen 50bps, yet
mortgages remained stable thanks to the block buying powers of the Federal
Reserve (yield spreads have tightened). The tighter yield spreads between MBS
and TSYs were beginning to draw some none Federal Reserve funded demand to our side
of the stack, this augmented funding added liquidity and increased demand side support for mortgage
rates. It was a GREAT MONTH FOR MORTGAGES...we essentially strengthened all month while the Treasury market weakened (we were off in our own little world!). Unfortunately this posture was predicated on
the assumption that the Federal Reserve would continue to artificially flatten
the yield curve via open market purchases. Well...after Wednesday, that "assumption"
has been amended. The FOMC's lack of yield curve friendly verbiage put MBS
buyers on the defensive.
When benchmark Treasury rates rise, the duration (expected
life of cash flows) of "out of the money" (at par or below par) MBS
coupons grows longer. The farther out of the money an MBS coupon is... the more
it's duration will EXTEND when benchmark
rates rise. This occurs because the borrowers backing those MBS pools will have no reason to
refinance if their rate is below current market. This means "current
coupon" MBS investors will be STUCK in an underperforming investment....an asset that is paying less
than what the market is currently offering!!! (That is extension risk)
Plain and Simple: If benchmark interest rates move higher,
available funds can be reinvesting at current market for a higher yield and more return. Because the holder of MBS coupon can't call the debt due when interest rates rise (only a borrower has call option on their
mortgage), that investor will be stuck in an investment that is UNDERPERFORMING.
Hence...real money and levered money will stay away from anything extension risk related...like"rate sheet influential" MBS coupons.
That is why we have seen so much RED lately...blame extension risk for the REPRICES FOR THE WORSE.
Now What?
At this point everyone wants to know WHEN, HOW, and IF
the Federal Reserve will flatten the yield curve. Until then...the Federal Reserve will be left to their lonesome to fend off any originator supply
offerings...and they will probably be sure to get a good deal when they do buy! This means things could get a little choppy for a time...but, we have faith! This is not grounds to enter panic mode. Remember: the Fed still
has $845 BILLION to keep mortgage rates near 4.50%....plus month end/beginning MBS SUPPORTIVE EVENTS
Here is a bit of optimism for you regarding volatility in the Treasury market....Yesterday the one day put/call
ratio on the 10 yr was 0.90, compared to
0.37 on Wednesday...this signals sentiments are equalizing in the Treasury
market as participants settle into the post FOMC paradigm.
At the moment...
Since 5pm "Going Out" Marks...
FN30________________________________
FN 4.0
-------->>>> -0-08 to 99-24
from 100-00
FN 4.5
-------->>>> -0-05 to 101-19
from 101-24
FN 5.0
-------->>>> -0-03 to 102-23
from 102-26
FN 5.5
-------->>>> -0-02 to 103-15
from 103-17
FN 6.0
-------->>>> -0-01 to 104-16
from 104-17
GN30________________________________
GN 4.0
-------->>>> -0-08 to 99-28
from 100-04
GN 4.5
-------->>>> -0-06 to 101-26
from 102-00
GN 5.0
-------->>>> -0-05 to 103-09 from 103-14
GN 5.5
-------->>>> -0-03 to 103-23 from 103-26
GN 6.0
-------->>>> -0-01 to 104-09
from 104-10
2s/10s: 223bps
Dow: -57 points (-0.70%)_ to 8110)
Before you go back to doing whatever you were doing... here is some hopeful perspective. Lenders locked in their profits when MBS prices were at the top of their trend channels. This implies that, regardless of the current MBS market, lenders have some room to offer aggressive loan pricing. Whether or not they do depends on the health of their pipelines, the amount buckets have been filled, and the behavior of competition.
PS...Welcome to HVCC HELL DAY 1