Posted
In the same sort of silence that infects an entire team of little league baseball players after their first blow-out loss, there is not much to say about MBS today. Just as the 27-0 scoreboard tells the story for our little league pals, so too do our charts tell the silence-inspiring story for MBS today:
Today's Chart:
Perhaps it's a mere curiosity, but could it be significant that once prices fell through the lowest close since the Fed announced it's buying schedule that this level was retested as a ceiling several times, all unsuccessful? It's almost as if the market is saying: "Fed buying never existed." Of course, this is too harsh of a sentiment to adopt and will be proven in the coming weeks to be far from the case, but an interesting psychological anecdote nonetheless.
What does this do to the chart of daily closing prices?
Yes, it erases every gain we've had since December and takes us back to levels not seen since the end of November. Harsh stuff indeed. If you're an optimist, the above chart tells you "could be a lot worse." If you're anything else, it's more like "Oh crap... Look how much more we can fall..."
But the big questions on everyone's minds are
- Why!?
- Will it come back!?
- When?!
WHY
We often get into the intracacies of fundamental MBS analysis, the yield curve and trade flow. This type of analysis can actually overcomplicate a relatively simple problem. Simply put, the specter of catastrophic recession/depression was a "mosquito" of indeterminate size that grew and grew according to different predictions. As these predictions homologated, the bug was seen to be large enough that Mothra would be intimidated. Hand grenades and RPG's would be scarecly sufficient, so anyone with a big gun lined that sucker up and let fly with the boldest arsenal of counter-deflationary stimulus this country has seen. At the time, it seemed that no countermeasure could be "overkill." Although this STILL may turn out to be the case, the current, most recent, and therefore ostensibly most-accurate accounts of the mosquito put him in a much more innocuous size range--so small in fact that "overkill," as many see it, has been far surpassed. If the mosquito is just the size of a small cat, per se, then the H-bombs that have been lobbed towards it by way of quantitative easing now appear that they will do much more relative damage to the "suckee" rathor than the "sucker." In other words, an industrial flyswatter would have sufficed, but the actual payloads are excessive to the point they have prompted another swing of the pendulum. Basically, the economy--or at least a big enough part of it--THINKS it's coming out of a "V SHAPED" recovery much sooner and much better than had previously been anticipated. That being the case, the current treasury supply combined with artificially low benchmark and MBS rates look more out of place than an MBS blogger at a Jonas Brothers concert. The reaction is to rapidly and dramatically vacate all positions that coincided with this seeming overestimation of economic desuatude.
That's about it as far as the big picture. "Everyone" thought the recession would be a certain way. Enough participants think it will be so much better that current treasury yields have to come up quickly and in large amounts. In almost no way does this story have anything to do with MBS except inasmuch as the fuel for MBS purchases comes from the now maligned "treasury supply." We are simply an unwilling dog on the yield curve's firm leash. Having tightened it to near it's limit, we must now go where it goes with little room for slackening or tightening. So the recovery looks better and better, treasuries and therefor MBS must sell and sell and sell. After discussing this with some inner circle today, a recent article in The Economist was brought to our attention in which many of the same points are addressed with many of the same explanations by the NY Fed President. Take a read... The first paragraph is a nice complement to the foregoing:
Q: Treasury yields are up sharply in the past few weeks. Why?
A: The economy is looking less dark so people are taking away the
Japanese deflation scenario. Basic financial conditions have generally
eased quite a bit in the last six weeks. If you thought the equilibrium
funds rate was wildly negative six weeks ago, it's not so negative
anymore. I don't know if the economy has turned out better than
forecast, but the adverse tail has diminished significantly. The risk
of the banking system melting down, the deflation outcome, has very
much diminished. And supply is enormous. Another thing of course is the
mortgage market, which has its own dynamics: rates go up, duration
extends. The third reason is some uncertainty by some people about the
whole exit from all these programmes and the possible inflationary
consequences of that.
Will It Come Back?
This depends on the extent to which you are like me in that you think markets "have it all wrong." Considering some of the more bearish facts and numbers that mitigate and underly recently bullish readings, one can't help but think there will be another leg down for the economy before the true recovery begins. Whether you want to call May a "dead cat bounce" or "bear trap" etc... doesn't matter. What matters is that if this "recovery" indeed turns out to be "W" shaped as opposed to the currently operating assumption of "V" shaped, rates will come with a similar speed to the pain of such a realization. Additionally, if the Fed or other federal entity manages to fire off a few creative bullets from it's magical mystery gun next week, this too could ameliorate a significant amount of recent pain. As we've said before, to assume the Fed won't at least address the recent back up in tsy yields is naive at best. The more likely (though not a foregone conclusion) eventuality is to see some sort of bullet fired as early as this weekend with a target time somewhere in the "next week" range. Long story short, opinion plays a role here, but even if not to it's paramount glory, whatever "it" is, is more likely to "come back" than to languish at current levels or worsen. Perenial market bulls may want to skip this assessment...
When?
This was basically answered in the last paragraph. The "when" can start as soon as one or both of the aforementioned begin to materialize, with the full effects of the "when" coinciding proportionately with a higher percentage of said materialization. In other words, if economic expectations, indices, growth estimates, indicators, etc... fall to mid-March levels, it wouldn't be long after that rates start singing a similar tune. So the seeds of this beautiful bush could begin to sprout soon, but the leaves and flowers might not be as appetizing as you'd like for a month or two. Keep in mind that this is an extremely random moving target and completely dependent on very unpredictable variables. Technicals call for 2 months or so in the lower area of this years range. That seems plausible considering that "area" allows for a wide margin of error and plenty of gains to re-enter the market.
What Next?
First: Gut Flop... Always...
Then, tomorrow is a pivotal day... If you have some risk tolerance to spare in your GutFlop, the chances that you'll be better off next week will be much better known tomorrow via either contrary or continued momentum than they are today which ended with selling, but failed to break through November 28th's lows. Simple recap: according to day, could push worse tomorrow or could be the first day of a rebound. The risk of worse prices in the AM is the cost of admission to find out. Take it if you like. Lenders will likely be hedged a bit on AM rate sheets if NFP sentiment hasn't pervaded trading patterns by the time rates are released. We'll also have a new prepay report to digest which could either help or hurt. We'll also have settlement-related trading which adds another layer of variability to the outlook. Unless I got catastrophically pounded by most lenders today, I'd probably lock the sensitive ones but float a slight majority ON PERSONAL OPINION that we see some better rates owing to moderating bullishness on the recovery or some sort of Fed intervention some time in June. I just cannot stress enough though what an important role that personal opinion is. Don't let mine influence yours. But use yours, take note of the result, and try to use it even better next time. I have legitimate reasons for expecting a bit of a rebound for bonds. Don't make the common mistake of allowing your default optimism for bond prices influence your true opinion on the state of the market.
Other than that, suit up for battle... The next five business days will be eventful to say the least.
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