Afternoon activity in the TSY market has perked up/improved enough to say we are leaning back to a neutral bias....for now (yes we are really looking at this situation with that much caution). The fact that volatility has calmed a bit indicates investors are beginning to trade a little more flat (selling straddles)...meaning the market is looking for volatility to continue to calm (NFP on Friday)....and investors are trying to make money off of the calmness/flatness...hence it is somewhat of a "no bias" bias. Regardless of the alleviated anxieties....volatility is still running at historic highs...so we remain prepared for psychological momentum (the perception of headline news) to sway us in one direction or another (rates looking for new direction).
Remember: the market is still extremely sensitive to a rise in benchmark yields and will not stray far from neutral positions (lots of negative convexity....the technical reason behind all the wild price swings).
Calming volatility is a good thing for "rate sheet influential" MBS coupons because it allows market participants to move "down in coupon" (out of short duration into long duration) with less stress about a violent upswing in rates (higher vols = wider OAS). If volatility can continue to compose itself then we will likely see market participants begin to move back into 4.5s and 5.0s as they are perceived to be best outright purchase targets (4.0 still too risky/not neutral)...on the other hand that assumes the street is comfortable allowing MBS/TSY yield spreads to tighten back to the recently visited yield spread tights (+70/10yr TSY).
All that said....the MBS market will likely range trade until market participants are comfortably confident that volatility has quieted. MBS range trading will be at the mercy of the gyrations of the yield curve...we anticipate the only range will be moderated by the perception of relative "RICHNESS" or "CHEAPNESS"....meaning yield spreads are controlling the price behavior of MBS coupons .....still.
We can say this about "rate sheet influential" prices though....servicers and originators keep selling FN 4.5 as bids near 100-00. These are the only two accounts that are affecting rate sheets at the moment as most othes are trading "up in coupon" to avoid negative convexity and extension risk. FYI Servicers MUST meddle in "rate sheet influential" coupons in order to protect/hedge their servicing fees
Cross your fingers and hope for the stock market's gentle realization that their recent behavior is "irrational exuberance". For now take your reprices for the better with a grain of salt...things are improving heading into Friday but the interest rates remain extremely sensitive...
By the way...
I know this is update quite technical and probably hard to digest...unfortunately the market is trading VERY technically at the moment..so it is what it is...
Dont worry...Matt and I will find a "Plain and Simple" way to clarify....
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