As AQ discussed in the last post, volatility took a vacation today compared to recent days.  After finding a bottom following this AM's housing tape-bomb (pending home sales up better than expected), it was a slow and steady march upward for MBS, all the while maintaining a relatively tight trading range.  Stocks and bonds were relatively tame in terms of volatility as well (though the later saw good gains, it was also in a resonably stable range).  All in all, the day was a net winner for MBS in terms of yesterday's close (up 9 ticks), which helped us JUST BARELY recapture opening price levels from today.  Here's today's chart:

The above picture looks half-way decent.  But as you're probably painfully aware, this is nowhere near Monday's open, which itself was a bit farther away from the preceding trading range than we'd probably like it to be.  The candlestick chart will tell that story fairly well.  Remember that the absolute highest and lowest points of a candlestick represent the highest and lowest prices of the day.  The rectangular part of the candle, known as the "real body" represents the open and the close.  If the candle is solid, prices moved down from open to close, if the candle is hollow, prices moved up from open to close.  Today, you won't see much of any "real body" as we opened within a half tick of where we closed.  It's very easy to see with candlesticks exactly where we traded today with respect to the past few sessions:

As far as the other "stuff" on that chart, we'll start with the yellow line.  This just shows the two lowest closing points over the last week.  In general, this is what we prefer after a sell-off: "higher lows."  In other words, the first day of the sell-off was the lowest close we've had, and even after yesterday's selling spree, we closed a bit better than Black Wednesday.  This is a trend we will watch carefully.  The longer the pattern of "higher lows" continues, the better.

Looking now at the red text, this simply calls attention to a pattern that today's candle adheres to.  That's one of the nifty parts of candlestick voodoo magic: they form patterns with funny names which in turn suggest things we can know about the trading action that a line chart might not otherwise tell us.  Whether it's better than a 50/50 shot at panning out is a mystery to me, but at least it will make you sound intelligent at your next cocktail party.  The "hammer" symbol we're looking at today is generally a good thing when it follows a period of weakness as it does here.  It indicates that although there was significant selling pressure earlier in the day, bulls fought back and brought the closing prices relatively in line with the open.  In general, the smaller the "real body," and the higher the close relative to the day's prices, the better.  So from a technical perspective, this is a pretty good Hammer, although it would be best if it was coming at the bottom of a selling pattern as opposed to just after it.  Treat this more as an "optimistic curiousity" than an indication of what will happen.  Other technicals and fundamentals are much more worthy of our attention at the moment.

The best candidate for this attention is an aspect of the market that AQ covered well already today when he said: "MBS range trading will be at the mercy of the yield curve."  It could not be said any more simply.  A few days ago, we noted that there was no inherent MBS illness due to the fact that spreads so quickly returned to their previous range (and then some) after Black Wednesday.  Then too, we talked about the yield curve being "back in the driver's seat."  Breaking it down a bit further: MBS have "risk" in that borrowers can decide when to sell or refi, thus altering the cash flow that an MBS investor was planning on.  The "spreads" we're so fond of discussing are the DIFFERENCES in yield between MBS and something "risk free" (such as treasuries) that investors require in order to buy MBS in order to offset that risk of prepayment.  When we say that treasuries are back in the driver's seat, it's because spreads have not only gotten very tight (meaning MBS prices have continually risen faster than tsy prices as MBS have become less and less risky), but also have shown little intention of going much tighter in the short term.  So if we are "stuck" in a certain range of spread, AND if MBS have shown very little predisposition to move too drastically in spread (for more than a day at least), it's up to the yield curve to move before the fairly narrow spread range allows for movement in MBS. If we look at the spread chart, we can see this range.

This might confuse some at first, but remember the yellow line is the DIFFERENCE IN YIELD between the always higher yield (because of higher risk) MBS and the lower yielding (because of zero risk) treasuries.  The line tells us that these two yields are hesitant to diverge too much too quickly since Black Wednesday.  The lower the line goes, the lower the MBS yield compared to TSY yield, the more we have to pay in MBS for the same return.  In that sense, MBS would be getting too expensive, and SELLING would bring us back to the middle.  The line goes too high and MBS yields are getting HIGHER compared to TSY yields, and we get more yield for the same price.  In that sense, MBS would be getting cheap.  REMEMBER, "expensive," "cheap," "selling," "buying," in this case would all be RELATIVE to tsy's.  So if we needed to SELL in terms of spread, if tsy's were doing very well that day, it could STILL be an up day for MBS.  Conversely, we could have an excellent day of "spread tightening" but still lose ground on the day if treasuries were getting hammered.

Bottom line, the lowers (tighter) this line goes, the more resistance MBS encounter as far as improving vs. treasuries.  After a certain point, we can do no better on a relative basis, meaning treasuries must improve before we can improve.  Not only that, but at that point, we'd be extremely unlikely to improve MORE than tsys.  And that puts a point on the bottom line: even if we have not reached the above referenced scenario yet, we are certainly seeing the semblance of it's effects as spreads have grown tighter and tighter.  MBS CAN go tighter still, but not only does it get harder and harder to do so as we tighten, but, at least for now, we appear to be "range bound, and at the mercy of the yield curve."  Seems like I've heard that somewhere before....

And this is why AQ apologized for the technical post in his most recent gem: the "why's" are more related to technical tradeflow at the moment.  As far as broad conjecture, there is one fundamental "why" that the crowds around some water coolers seem to agree on: It seems that the dominant sentiment judging by stock prices and trading patterns at the moment is that our economic recovery is "V-Shaped," in that it has already bottomed out and a similar rate of improvement in economic indicators will persist until everything is sunshine and lollipops. If that's the case, treasuries are overbought, and the Fed has tricked the rest of the market into buying cut rate MBS that will never ever prepay and will be paying a mere pittance of market return by the time the recovery is in full swing (sarcastic hyperbole intentionally included).  The crowds around our favorite water coolers however (bears only) seem to think the recovery will take more of a "W" shape, in that we have another leg down before the bulls finally get their legs up, so to speak.  AQ has asked this before, and I'll ask it again: Do you think the Fed, if it's at all in their power, will sit by and do nothing if market movements are essentially rendering the entirety of their open market operations completely innocuous?  Methinks no, and I'd wager there are a few youthinks out there as well. 

With that in mind, tune in for tomorrow's reactions to some scheduled open market operations by the fed in the 5-7 yr range tomorrow.  We also get Dr. Ben at Ten, along with factory orders and ISM non-mfg survey, all preceded by the Wednesday ritual MBA purchase applications at 7AM.  Focus goes to Bernanke and the reaction to the tsy buying.  (notice we said "REACTION" to tsy buying, and not necessarily the buying itself!  We'd had to assume a logical connectedness on anything bond-related these days...)