Volatility has taken over.
Volatility in MBS, Treasuries, Commodities, Currencies, Swaps, Stocks, and most of all in Sentiment. Some feel confident, some renewed, some tired, and others subdued. The main theme governing the wide assortment of outlooks and opinions.....THE BIG PICTURE situation. The broadly believed market participant perspective...the "worst has been avoided". The Fed managed to steer the US economy clear of a deflationary spiral. Yay! The Dow has rallied over 2,000 points in a little under three months. Woohoo! Yay! The Recession is over!!!!
Well not exactly...the 2500 point "worst case scenario"discount that was priced into the Dow has, however, almost been totally recovered...
The market does appear to be "refreshed" by some of the recent better than expected data. This feeling has spread and confidence has picked up momentum in the last week. Remember? First it was consumer confidence, then came Personal Income, followed by Construction Spending, and ISM data, then everyone got a little more excited because continuing claims failed to shatter a 17 week record of breaking its own record. Then came the icing on the confidence cake....Non-Farm Payrolls printed better WAY BETTER than ever imagined...and investors breathed a sigh of relief. Phew! The "worst" really is behind us....
So now what? Is the economy in recovery mode? Do we test 10,000 on the Dow? Or is the market getting ahead of itself? Will rising rates deflate equities? Will rising rates ruin the housing recovery? WILL RISING RATES RUIN THE RECOVERY?
The market is desperately seeking directional guidance. Everyone is unsure. The Fed sees stabilization, but remains skeptical of stability. Stocks see recovery, but still request reassurance. Bonds have been rudely awakened by a deflating dollar, a ballooning budget deficit, and a chaotic convexity crowd. Welcome back to reality fixed income sector! I hear you enjoyed your time with the Fed.
Well a perception of reality that is. For some reason everyone (the herd) started questioning the forecasted fallout from the Federal Reserve's drastic balance sheet expansion. The herd's "headline news" focus shifted from the labor market to the Treasury Department's bid list. The dollar weakened while commodity prices made record gains...very, very bad for fixed income. (liquidity bye bye. negative convexity hello)
Look whats happened over the past month ....
Look what's happened over the past week...
Look what happened today!!!
Remember the artificially induced liquidity lull we enjoyed from March to May? The Fed drew us into this daze with a daily dose of bid side mortgage support. $5bn a day was easily erasing intraday volatility. Any lender supplys offerings were effortlessly absorbed by the Fed. Volatility was on vacation as hedgers were hesitantly absent. MBS ALERTS were few and far between. MBSer concerns were limited to tape bombs and racing speeds while originator anxieties revolved around lender penny pinching, and fence sitter foolishness. Everything was great. Boy do we miss those days now!
I know I know.. WHAT NOW?
Seriously we dont know. The fixed income market was so rudely awoken by the "new reality"that market participants are still trying to locate their bearings after the chaotic capitulation-esque events that have occurred over the past 10 days. Traders have been busily positioning and repositioning....buying strangles, selling straddles...selling calls, buying puts..and so on and so on.
Plain and Simple:The market undecided and desperately seeking new information that might help it determine its own fate (since the market is always right. RIGHT?). The only option available for the fixed income sector: ensure your trade positions account for a wider range of economic outcomes. Short one thing, go long another. Buy rumor, sell news. Bargain buy then profit take. "Wait and See"....and in the mean time find a way to make some money! Utilize short term strategies to occupy the mind and protect portfolios from...well one of the wide varieties of outcomes that might occur.
The probelm is in the process of all this "repositioning"...mortgage rates rose 50bps!!!This is bad!!!! Now add high mortgage rates to a long list of issues that are preventing borrowers from calling their option (embedded that is....their option to refinance!). Lets revisit the rest of the list just for fun... jobless homeowners, tighter lending guidelines, lower FICO scores, LLPAs, stingy rate sheets, long turn times, an appraisal process that involves throwing a dart and hoping for the best, uhhm...,what did I miss?
We need a game changing, sentiment shifting event. The market is looking for guidance....
Well here is a little guidance.
AND....
...from Ben Bernanke's prepared testimony, June 3, 2009, Before the House Budget Committee:
"We continue to expect overall economic activity to bottom out, and then to turn up later this year. Our assessments that consumer spending and housing demand will stabilize and that the pace of inventory liquidation will slow are key building blocks of that forecast."
Ok ok hold on...this isnt so bad, one could take postivities from this. Ben said "stabilizing" housing demand. Not recovering. Fair enough...housing appears to be showing some signs of stabilization. So no worries...oh wait...
THE FORECLOSURE MORATORIUM IS OVER!!!
Ugh...once again, we revist those same ol' hot topic questions...
Will "stabilization" (as the market percieves it) be possible with 14.5 million American unemployed? Will "stabilization" be possible if mortgage rates hover in the mid-5.00% range ? (btw rates are higher if your FICO is under 680). Can the macroeconomic recovery take place without housing? Is the stock market getting ahead of itself. IS THE ECONOMY REALLY RECOVERING.. or have we merely avoided "the worse case scenario"? So far the Dow indicates the latter...but Monday is a new day and equity investors will be asking themselves these very same questions.
I know I know I know...WHAT NOW???
We are waiting for a "game changing event"!!!! Some sort of tapebomb that puts reality back in perspective or reassures that a "new reality" has formed. Maybe the Fed announces more Treasury purchases (ugh..WEAK!) or perhaps they create another lending window dealers can swap Treasury debt at. What if income earned from Treasury investments was deemed tax free? There is always the outside chance that economic data gets revised for the worse, or maybe new data is just as suprising as todays Non-Farm Payroll read...but in the "worse than expected" way. Even better...perhaps it will come to light that the 14.5 million unemployed Americans cant get a job because no one is hiring (that is bad for housing all together). Might as well throw in the theory that rates historcally rise in the summer? (but this much yield curve steepening in such a short period of time?)
Plain and Simple: We need to find a range. The only way a range will be found is if new details come to light that force volatility out of the marketplace. Go away volatility!!! Until then...more "wait and see" trading tactics...more reprices for the worse...and more #@&*! mutters from the crowd. It is what it is...
Actually maybe not...Matt has some thoughts too. Dont you love the two different perspectives we offer?
Hi all. Thank you AQ...I will call you later to tell you about Vic's latest truck stop story. He loves the turnpike! (AQ is laughing out loud...we like to mess with Vic...he is good people). Ok my turn...
If the question had been posed yesterday: "what will the markets do if the print on NFP is under 400,000 jobs lost?" Few would have expected today's reaction. Sure, there was the initial intuitive tanking in bond yields as well as a strong spike in stock futures, but things came back into ranges on all fronts that seemed too bearish to hold into the afternoon. Yet they have. Stocks saw a series of lower highs as the Dow worked its way down to 8763, a mere 12.9 gain on the day. After spiking as high as 3.9, the 10 yr tsy moderated into a narrowing range capped by 3.86 on the upside and is now a bit lower at 3.83. MBS descended a vary narrow, very gradual slope into a low 98 handle and whereas the overall change on the day has been quite negative, most of the losses came in the AM with the action since 1pm being extremely sideways.
See if you can see what I mean:
No?
Is this better?
There are some broad, but very serious resistance ranges at play here. We'll get to that in a moment. When things move as much as they have recently, it suggests a need to take a look at longer term technicals than necessitated by our previously narrow and insular range. First, we can look at 3 quarters of 4.5 coupons (we'd do the full year, but there's so much negative convexity at the lows, it's senseless).
Should we be interested that our first major patch of turbulence on the way down was right at 62%? I think we should. Should it matter to us that we arrived exactly at a 50% retracement today? I think so. But to get a sense of WHY it matters, let's do something that, at one time in not so distant memory would have been considered MBS heresy. Seeing as how we are so very intertwined with the yield curve at the moment, let's see if there are any pertinent levels emerging in tsy's.
Well I'll be! Throughout 04 and 05, this line served as support. Even in late 07, it was the first major resistance after the yield fell out of it's range. After dropping below this in '08, just before the credit crisis kicked into high gear, it has not been seen again, despite a couple "thwacks" against it as a ceiling before Lehman/AIG weekend. As you can see, we are on an absolutely brutal tear towards it now. If we cross, could be bad, could be real bad. But history also shows in 07-08 that the line can be danced around to a small extent. Whatever the case, what the MBS optimist would like to see is some more suspicion cast on the "V-covery" (V shaped recovery) that coincides harmoniously with this 3.97 line giving the yield line the old smack down. That would be a very promising technical indicator indeed, and what's good for our benchmarks is good for us.
Plain and Simple: enjoy your weekend...we're in for a wild ride!
-AQ and MG
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