Posted
Selling in the stock market has stalled at a key technical level....the 62% retracement of the 888 low that was hit on June 23. This is firm support, however given the shortened holiday work week, it is quite possible this price point collapses. If this floor is broken the S&P's next level of support is 888.
That said, since the stock lever appears to be playing a role in the gyrations of the yield curve...as selling in equities has stalled, the 10 yr note yield has run into resistance at 3.49/3.50. This yield range has proven strong resistance for the 10 yr note. If stocks do move lower and 10 yr trader test 3.48, and do not fail, the 10 yr note yield could test 3.45. However, the same factors limiting stocks, a long holiday weekend, will likely moderate gains for the 10 yr TSY note. Dont look for the 10 yr note yield to move too far past 3.48 (unless stocks really tank).
Now for MBS...
This morning some lenders have reportedly been locking in their loans
on the MBS market. This is a function of "rate sheet influential" MBS
coupons reaching their perceived price ceilings...the FN 4.5 cant seem
to break 100-00 and the FN 5.0 venturing too far past 102-00. That said, loan officers and borrowers are enjoying the rally in "rate sheet influential" MBS coupons, unfortunately we may have seen the best prices of the day in "rate sheet influential" MBS coupons. This yield curve led rally has however allowed lenders to improve mortgage rates a few bps.
Here is a two day look at the FN 5.0....
The MBS trading environment remains defensive. Market participants
still broadly prefer to avoid extension risk heavy "down in coupon"
strategies as there are far better, shorter lived "up in coupon"
positions that can be taken (minimal prepay risk in the mortgage market
right now)...leaving the Federal Reserve alone to fight off originators and servicer selling. This is a function of high volatility in the trading environment, or more simply, the fact that the BIG PICTURE is still very unclear which is forcing investors to stay away from current coupon MBS.
Let's expand...
When
benchmark interest rates (TSYs) rise both the duration and expected life of
"out of the money" (at par or below par) MBS coupons increase (longer
life). The farther out of the money an MBS coupon is, the more it's duration
and life will extend (can only extend so much though)
because the borrowers backing the loans that make up the MBS have no reason
to refinance if their interest rate is lower than prevailing current market rates.
Plain and Simple: MBS buyers dont want to be stuck in
a fixed income investment that isn't keeping up with its benchmark (benchmark
yields higher than MBS coupon yield)...if interest rates move higher this implies
those MBS holders could be reinvesting their money in a higher yielding debt instrument...they
could be earning more return/MORE CASH FLOWS!!!!
Now lets
apply the academic background knowledge to the current volatile/choppy
interest rate environment. Remember Black Wednesday? Remember the crowd fleeing
a burning building? Snowball selling? Traders do not want to put themselves in that position
again. This is a function of the BIG PICTURE OUTLOOK which remains a BIG MYSTERY. The BIG MYSTERY
has brought about a higher amount of volatility in the marketplace (volatility in options market). More
volatility implies the outlook for forward looking interest rates is wider,....meaning there are more unknowns as anything
can happen!Well if the "unknowns" end up being fixed income negative and benchmark rates rise, the life of "rate sheet
influential" MBS coupons grows longer and longer. The extending life of
those MBS coupon cash flows is a scary thing to investors because it means they could
stuck holding an MBS coupon that is under-performing the yields of current
market risk free benchmarks (bc only the borrower can exercise the embedded
call option in MBS)...which brings us full circle. Hence why we have seen
panic-like selling of "rate sheet influential" MBS coupons every time
Treasury yields start to rise. Hence why
MBS investors are hesitant to jump on the TSY rally bandwagon...hence wider
MBS/TSY yield spreads! Hence why we have said there is little room for "rate sheet influential" MBS coupons to move much higher. Negative Convexity 101.
The Treasury
Department has just announced the amount of TSY coupons they will auction off next week
3s, 10s, 30s
are all unchanged from previous issuance. 35bn 3 yr notes. 19bn 10 yr notes,
11bn 30s.
The Treasury
will also auction $8bn 10 yr TIPS
Following the release the 10 yr note ticked up to 3.5.
Looks like MBS gains are capped out today....
2s vs. 10s:250bps
MBS QUOTES
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