Interesting happenings going on in MBS market today. The yield curve is noticeably steeper, which would usually force "rate sheet influential" MBS investors "up in coupon" as extension risk grows and prepay risk dissipates. However, this is not occurring at the moment (not broadly at least). Instead we witnessed "down in coupon" buying as prices cheapened up...the source of this support was of course  the Federal Reserve plus a few "tag along" buyers. Yay right? Tighter yield spreads, MBS outperforming TSYs, buying on weakness....all indications of some demand side stability in the MBS market (albeit from the Federal Reserve).

In your eyes this support is likely not too inspiring as your perception of rates reality is broadly based on the underlying price action of "rate sheet influential" MBS coupons. And because prices are lower today, lenders have passed along higher mortgage rates/less YSP (base pricing +servicing!) the previously pointed out positivity's are relatively irrelevant to you. (you get my PUN there? RELATIVELY...HAHA. No? Relative value? Wow im a geek).

Well I have some positive news for your perspective markets have gone range bound/stagnate, MBS prices have stopped falling and are off the lows of the day! Yay? No Yay???Come on throw me a frickin bone...its been a crappy week, im trying to give you some hope heading into the weekend!

Unfortunately today's "down in coupon" bias isnt much of an indication of things to come (your optimism gone?). Adding to that outlook (or lack thereof) is the fact that its a Friday afternoon in the middle of a summer trading session, meaning traders are probably more focused on Tiger making the cut vs. their occupational responsibilities.

What will provide a better indication of things to come?

Today...probably not much. Its a summer Friday and the JV team is manning the fort! However we can try and postulate a theory based on the "week that was"....

If you havent noticed, the yield curve has been taking its directional guidance from the stock market lately. After getting the "be all, end all" of head fakes from the "head and shoulders" pattern, the S&P is 70 points higher in the past six trading sessions, looking to make new 2009 event that has not been friendly to TSY, MBS, and mortgage rates!

That said...everyone is asking when a correction will occur. WAIT...WILL A CORRECTION OCCUR? Lets take a peek (peak...another PUN!) at the possibilities...

Logically, as the S&P attempts to approach 950 we would expect traders to get more defensive as there are a plethora of psychological and technical resistance points near this price level. Any rational trader's strategy should then include a fair amount of skepticism regarding the question: how much room is left for stocks to rally? If so, we should see volatility in the options market increase (VIX higher) as market participants prepare for the notion that 950 will cap the recent S&P rally. We should see protective positions placed and profit taking begin...something we havent seen much of today.

Another indication of strength or weakness to come can be offered up by researching the market's profile. Is volume picking up as prices cross specific resistance levels? What price points are peaking trader interest? We are looking for the S&P to test yesterday's high price point to confirm further room to run, but want to see some volume! At the moment the S&P cant seem to break into positive territory as gains have been capped at 942..and volume is light. The S&P reaching 950 in high volume...that means something. The S&P reaching 950 in light volume...doesnt really mean anything.

Lastly...this rally has been extremely odd and very unusual....reckless breaks of resistance levels and a total ignorance of oversold indicators....this rally has totally over-extended its welcome (in options expiration week too!). There have been no proper periods of consolidation or exploration of support levels. Where is the logic?

Plain and Simple: This rally is like a runaway train ....with everyone not in cash jumping on board to enjoy the ride. Any day now we'd expect to see profit taking...and if that theme catches on, it might be difficult for buyers to fight off the excess supply of sellers...thats how your "correction" could occur, thats how bonds could take back their bullish bias. If that sort of selloff fails to slow bullish momentum in equities...then this rally has legs...legs that will want to run.

This is not a value led rally (fundamentals). Its all about momentum. We're waiting for logic to prevail....its a trader's world, we're just living in it!

2s vs. 5s: 152bps

2s vs. 10s: 265bps

5s vs. 10s: 114bps


PS: Oil is ignoring a strong dollar and weaker stocks...ODD AND UNUSUAL!!!