There has been a notification day induced hustle and bustle about MBS world this morning. The roll market is on special!
THE ROLL MARKET?
Yes the roll market. Make sure you read MBS MORNING for background on MBS trading settlement procedures...
For various
reasons like low supply of MBS, slower/faster expected prepayment speeds, LIBOR rates, an open short position,....you can choose to lend your MBS coupons to someone who needs it
more than you do at settlement. When you agree to loan another MBS investor
your pool of loans they must agree to sell you back a similar pool of MBS on the next month's settlement date.
Here is an
example of how it works...(long standing readers have seen this)
Say hello to
Dealer A and Trader B. Dealer A owns a pool of MBS. Trader B needs a pool of
MBS right now.
Trader B
calls up Dealer A and says "hey I really need those MBS you own, can I
borrow them from you? I promise to give them back to you next month."
Dealer A
says "yeah that's cool but I need some form of collateral just in case you
don't give them back. I prefer cold hard cash and by the way you aren't the first person
to call asking to borrow my pool of MBS...so how about you pay market price for
the current TBA delivery month? And another thing I will only agree to let you
borrow my MBS if you promise to sell them back to me next month on settlement
date."
Trader B
says "Great! I only need to borrow your pool of MBS for one month anyway.
Everything sounds good I only have one question...At what price do you expect
to purchase them back?"
Dealer A
says "Well, considering that while you own my pool of MBS I am missing out
on all the coupon payment cash flows(income)....I am going to need to be compensated
for that loss of income."
Trader B
says "Ok that is fair. Don't forget you can always take the cash I am
giving you as loan collateral and re-invest it
in some other short term liquid trade (like Fed Funds). Just be sure to
put that money in a very liquid market so you can repurchase the pool of MBS
back from me next month!"
Dealer A
says " yeah you're right I can reinvest the funds you provide as
collateral, but I must remind that I am not only losing scheduled cash flows, I am missing out on the unscheduled
prepayment cash flows that we have forecasted to occur in the next 30 days. So
we need to take that possible loss of income into account before deciding on a
repurchase price. Ok....after doing my breakeven calculations I will only agree
to this transaction if you are willing to sell me back my pool of MBS for 10
ticks less than what you are paying me today. It's only fair to compensate me
for my scheduled and unscheduled loss of income over the next month. Plus I get the feeling you really
need a pool of MBS right now so I can add a premium to todays ask price"
Trader B
says "Ok fine I can't get anyone else to lend me the pool of MBS and I
need to cover a short position....but there is one problem. I can't sell
you back the exact pool of mortgages that you are lending me...I can promise to
return a replica of your current pool though. Is that ok?
Dealer A
says "I don't know...my pool of loans in performing. Well you are
compensating me nicely.....ok fair enough but you have to return a pool of
substantially identical securities...no funny business here I want loans issued
by the same agency, with the same maturity and identical coupon rates"
Trader B
replies "ok you have a deal. Sell me your pool of MBS today and I agree to
sell you back a pool of "substantially identical securities" next
month on the settlement date. In order to compensate you for lost coupon
payment cash flows I agree to offer you a cheaper price when I sell you a
similar pool of MBS next month. Talk to you on notification day. Later Dealer
A....oh haha before I forget....our firm's team plays your firm's team
tonight....our DH played for the Mets...good luck buddy"
Dealer A
responds quickly "The Mets are garbage, we ain't scared sonny."
Trader B
says "hello heeello aah he got me!"
There you
have it. The dollar roll trade explained.
This trade, the rally in Treasuries, and some bargain buying from real money accounts (that is a really good thing) are contributing to the intraday rally in "rate sheet influential" MBS coupons this morning. Unfortunately going into the 1pm 3 yr note auction we will likely see some profit taking in TSYs which will lead MBS lower. Here are the last seventeen auctions...
This auction will set the tone for the rest of the week.
MBS QUOTES
I forgot to post normal MBS OPEN data this morning....
6/8
EFFECTIVE FED FUNDS: +0.00 to
0.21 from 0.21
LIBOR
FIXINGS
O/N
LIBOR: +0.0075 to
0.2688 from 0.2612
1
MONTH: -0.0019 to
0.3212 from 0.3231
3
MONTH: -0.0025 to 0.6475
from 0.6500
6
MONTH: -0.0163 to 1.2663
from 1.2825
1 YEAR: -0.0187 to 1.8350
from 1.8537