WELP...the S&P moved below 946 and a flight to quality bid added momentum to today's fixed income rally...elevating MBS to facemelting status.
If you are looking for some fundamental reasoning behind this rally...the slow economic recovery process was highlighted by Chairman Bernanke this morning, sparking a "flight to safety" rally in benchmark TSY notes. This "spark" added momentum to the already underway bargain buying that was occurring at TSY price lows...more snowballing! BTW the TV tells me that the Caterpillar earnings conference call was pessimistic and part of the reason for stock selling...I wasnt listening to the call nor were any of my pals so this rumor has yet to be confirmed.
The 10 yr is 1-06 higher in price (38/32 or 1.1875) yielding 3.46%. That is a 20 bps drop in yield...in one trading session!!! Over 800k contracts have been traded, implying there is strength in this rally. Here is the technical significance of the price points on an hourly chart (the chart I showed you this AM was a 1 min interval)....after breaking through 3.62, 3.53, and 3.51...the most recent July 14 3.46 yield low is offering price/yield resistance...
The flatter yield curve has increased buying activity in the MBS market as investors attempt to adjust their portfolios to account for lower benchmark yields...the buying activity has come from loan servicers looking to add duration to their MSR portfolio (mortgage servicing rights).We refer to this event as "buying convexity".
Reminder: as prices of benchmark TSYs move higher and yields move lower, the duration of "rate sheet influential" MBS coupons decreases. This means the prices of current coupon/"rate sheet influential" MBS less sensitive to a small rise in benchmark rates and forces certain MBS holders to move "down in coupon" to match the duration of their liabilities with the duration of their assets (loan servicers are big convexity buyers). Moving "down in coupon" into lower coupon MBS adds duration to the portfolio.
This added demand side support has pushed prices of the FN 4.5 MBS coupon 20 ticks higher to 100-06.
Here is the S&P selloff. 946 was a key support level...
Why 946?
That was the previous 2009 S&P high! The move below should force some traders to take profits as participants consider whether or not the recent stock market rally was "too much too fast". This sentiment will be reflected by an increase in stock market options volatility. For you...watching the VIX is the easiest way to monitor equity market volatility. So far today the VIX is about one point higher.
Here is the S&P daily view...946 is key technical and psychological price point!
HERE IS A TUTORIAL ON FIBONACCI RETRACEMENTS
There have been broad based reprices for the better in the primary mortgage market. Mortgage rates are now under 5.00% for the most qualified customers (who should expect to pay points if rates are below 5.00%). In regards to the pricing strategies of mortgage banks...we have noted that a few lagging lenders have passed along aggressive reprices, we have however also noticed other lenders not being as "giving". This is a function of the fact that many lenders were already priced aggressively relative to MBS coupon prices (secondary market)...meaning there wasnt much room for them to pass along further gains.This reflects a little more competition in the mortgage rates market!
Looking forward, the volume behind the rally in rates is promising for mortgage rate watchers, but we are still defensive of profit taker and better than expected earnings reports (MORGAN STANLEY TOMORROW).
2s vs. 5s: 143bps
2s vs. 10s: 257bps
5s vs. 10s: 115bps
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