Posted
The rates market is defensive as most markets are essentially trendless...randomly testing resistance and support levels...in search of NEW DIRECTION!!!
The S&P has moved above 928 this morning....look for this price point to prove hard to break.
Meanwhile the 10 yr yield has gyrated higher and lower in step with stocks...
WHY SO DEFENSIVE?
Downside risk greatly outweighs upside potential. Negative convexity 101.
At this point, the yield curve has rallied to the point where heading lower would require an "event" that provided a clearer picture of "WHAT NOW", an event that scared the herd into safer assets (TSYs). The release of Non-Farm Payrolls data tomorrow is the next high risk event. The market is basically in waiting mode (trendless), just itching for directional guidance from a data print. In the mean time traders are occupying their time by poking and prodding at technical price levels. This has resulted in a bit of choppy trading action and some added volatility. More volatility implies more unknowns...more unknowns implies an increased need to protect portfolios from a wider varitey of outcomes. When I say protect portfolio I mean hedge. Which is what we've witnessed over the past few days in the rates market...hedging against unknowns.
Check out what swap rates have done over the past week...the rates market is NERVOUS
Rising swap rates not totally indicative of mortgage related convexity hedge, there are other forces at work here..ie corporate rate lockers, but still illustrate the skittish sentiment.
Swap Spreads are getting wider too...
Fixed income traders are well aware that downside risk is much larger than the upside (in MBS world this is illustrated by the FN 4.5 not breaking 100-00. and the FN 5.0 not breaking 102-00, plus consistently widening yield spreads). Meaning there is far more room for yields to run to the upside compared to the room for a rally (that would push yields lower). Dont forget the analogy we use to describe the downside risk in MBS and TSYs....a panicked crowd fleeing a burning building. This implies the possibility of a massive selloff looms in fixed income world. We are waiting for guidance on that....
THAT SAID...dont freak out.
Technical indicators are still bullish, albeit slightly less bullish then they were last week. But the BIG PICTURE is unclear, the WHAT NOW question has many outcomes with each economic report shining a little more light on the outlook.
Longer term, I think I have made it quite clear that my outlook is for a long period of economic stagnation(duh?). Our economy is extremely weak as the labor market is no where near recovery, corporate revenue models need to be redefined and proven efficient, then new jobs need to be created. GO BACK TO SCHOOL!!! On top of all this...HOUSING remains a huge issue. (No need to further explain this either...we have done a decent job of pointing out all the inefficiences and roadblocks to recovery in housing).
Whats all this mean?
You tell me, we'll say markets remain range bound until the broad audience realizes that we have a very long and frustrating journey ahead.The question is: what in world is the range? Between 3.50 and 4.00 on the 10 yr???? Waiting for guidance...
I know I have given you essentially no indications of our short term outlook. If you are wondering whether to lock or float...short term TECHS are still bullish, but the rates market is super skittish ahead of the release of Non-Farm Payrolls. On top of that quarter end window dressing and month end index activities have left the street in mostly long TSY positions. If we didnt have an "event" (NFP) ahead we would be much more disposed to direct towards locking as the overbought feeling in the long end of the curve was unwound...but we DO have an "event" looming...so we remain slightly bullish on lower rates, but EXTREMELY DEFENSIVE. Remember...crowd fleeing burning building! If jobs data is "not as weak as expected"...rates will move higher. If jobs data is as weak as expected or weaker...that will relieve some of the selling pressure we have dealt with in the past 24 hours.
Here is a two day chart of the FN 5.0...
For MBS specifically...seeing a mad rush "down in coupon" is not likely unless traders fear of prepayment risk intensifies. Low mortgage rates are not enough to spook these market participants though, we need some added assistance in the form of common sense underwriting and reduced risk based adjustments. We need some common sense in the home valuation process. We need lenders to lend! There are still too many overlays/protective roadblocks in place to ensure mortgage bankers dont lose their pants in mortgage world again. Can you blame them for being nervous about who they lend to? I cant...but I would at least like to see some common sense make its way back into the underwriting process
In regards to mortgage rates...the potential for higher rates means less fear of fallout risk/rate flip requests....but also adds a dimension of "qualification risk" and loss of borrower interest. Its all about pipeline managment at the moment.
That said...rate sheets are erratic. Some are noticeably better this morning...perhaps in an effort to lock up some loans before rates rise and borrowers lose interest, while others are worse as the competitive environment warrants no need to rush into any aggressive strategies. Lenders too are in...waiting mode. Reprice for the worse alerts remain a constant anxiety as any selloffs have the potential to snowball. You should be defensive too...always GUTFLOP.
2s vs. 10s: 249bps
MBS QUOTES
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