WAIT WAIT WAIT...
In MBS LUNCH I wrote that a
feeling risk aversion was beginning to set in over the marketplace as
overvalued stocks were showing signs that the rally has lost steam. I noted
that this bias would likely have positive implications for mortgage rates.
I dont think I conveyed my message
clear enough. Allow me to clarify...
FLOATING IS SUPER
RISKY
In order for those mortgage related positivity's to take
place...stock markets need to sell off and the rates market needs to find some stability. Although the recent rally in rates is
definitely progress in the right direction...NO TREND HAS BEEN CONFIRMED.
MARKETS ARE STILL SEARCHING FOR GUIDANCE.
Lets do something we havent done in a
while... look at big picture fundamentals.
In October 2008 domestic stock markets
baked in a "oh crap this might get ugly discount" into equity
indices. This reflected the fact that the Federal Reserve, Treasury Department,
FDIC, etc had to take historic actions to prevent the entire banking system
from failure.
Following the street's "oh
crap" sell off, markets went sideways for a few months after the Fed implemented
several programs to restore liquidity and stabilize sentiment. Then in
February, as labor, manufacturing, housing, consumer spending, business
inventory, (etc) data began to illustrate the extent of which the US economy
had weakened...the market baked in a "worst case scenario
discount"...meaning all out depression was possible.
However, as economic indicators began
to stabilize and some signs of bottom began to emerge..the market quickly
recovered that extra discount. Since bouncing from March lows...markets
have been stuck in the "WAIT AND SEE" STATUS QUO RANGE.
Now fast forward to present time. After
beginning to head back towards
"worst case scenario" levels in late June, stocks quickly bounced back, breaking through
overhead "wait and see" range resistance. All of a sudden we were at
the 2009 S&P high point. Huh? Wait...what the hell happened to shift sentiment in such a short time frame? What happened to the focus on stagnate economic output? Weak consumer spending? Commercial Real Estate's looming demise???? Low rates for an extended period of time? How did we reverse course so fast?
Was it "less worse than
expected" economic data? Maybe earnings reports that beat the street's low
expectations?
Market analysts claim that corporate balance sheets have been wiped
clean as excess costs have been shed. Participants state that big banks have
dumped "bad" (legacy/toxic) assets and have minimal exposure to
commercial real estate losses (smaller banks hold that risk). The stage has been set for the rebuilding. Traders are
now focused on HOW FIRMS WILL GENERATE FUTURE REVENUES instead of deciding on big of a"WORSE CASE SCENARIO" discount to bake in. That is indeed progress...but are those strong
fundamentals? Is that what is really driving this marketplace?
Nah...fundamentals have been useless.
This
rally has been defined by the technical trading strategies of revenue building money center banks who have dominated meager trading flows ...which
is clearly illustrated by the trading revenues numbers posted in dealer earnings
reports.
Logic has been absent and all rational retracements have been ignored
as traders have lost perception of the present values of unknown future cash
flows. The equity market is a freight
train, and although not loaded up with passengers, has achieved runaway
status...and no one is willing to step up to slow its momentum. Ride the profit train as long as it will take you..then jump off and ride the other way.
So what now? What does this mean for mortgage rates?
Dont know. The trend of us offering up
more questions than answers continues. But we can look at the previous price
behavior of our benchmark guidance givers for possible outcomes..
From December to May a massive demand for
"risk averse" assets (flight to quality) combined with Federal
Reserve funding kept interest rates at record lows. However as the market began
to unwind the "worst case scenario discount" in stocks...the yield curve
steepened aggressively....heading from "worst case scenario rally" levels back towards its own "status quo" range.
This rapid rise in interest rates was a
function of the market being rudely awoken
from a Fed funded liquidity lull. All of a sudden it became apparent that the
Federal Reserve had lost control of the long end of the yield curve....snowball
selling occurred as the crowd of safe haven hungry risk averse investors quickly fled the burning
building. (Crowd= long of yield curve risk averse investors. Burning building = extension
risk). In less than two months the 10 yr TSY yield and MBS current coupon rose over 100bps...sending mortgage rates into the high 5's.
---------------------------------------------------------------------------------
<PAUSE FOR EDUCATIONAL OPPORTUNITY>
Why did higher TSY rates push the MBS current coupon rate up?
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) when benchmark rates rise
because those borrowers backing the loans that make up the MBS have no reason
to refinance if their interest rate is lower than current market.
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!!!!
END EDUCATIONAL MOMENT
----------------------------------------------------------------------
Remember Black Wednesday? That was the crowd fleeing
a burning building. Traders do not want to put themselves in that position
again. So fixed income investors have been defensively trading with a
constant eye on the sentiment of stock markets. Yields have bounced around wide
ranges...driving duration (convexity) hedgers nuts as they keep up with the
violent gyrations of the yield curve. Loan officers and borrowers alike have
become numb to the unstable environment..one day rates are at 5.00%, the next
5.25%....
This volatility is a function of the BIG PICTURE OUTLOOK...an outlook that remains a BIG MYSTERY. More
volatility implies the outlook for forward looking interest rates is
wide....anything can happen! Stocks, TSYs, MBS, CMBS...ALL UNCLEAR OF THE ROAD AHEAD which implies markets will remain volatile and a lack of fundamental logic will likely prevail as TECHNICAL TRADING STRATEGIES CONTINUE TO DOMINATE MARKET FLOWS.
With fixed income taking directional guidance from this group of profit hungry traders (DEALERS)...are you willing to bet your income/mortgage payment on the behavior of these market participants?
We say, even though the rest of the market is acting with a complete lack of logic, you shouldnt lose perspective of rate sheet reality. Manage your pipeline with a rational outlook. Look at the recent highs and lows of your YSP/offered mortgage rate...if your rate/income is at the better side of the range...DONT GET GREEDY! When deciding whether or not to lock or float remind yourself of the current volatile state of the rates market.
Plain and Simple: Yes. Stocks are showing several signs of weakness. But this means nothing right now...technical trading strategies control trading flows and anything can happen! Dont forget how volatile the market has been, manage your pipeline relative to recent averages. If pricing/rates are good, dont wait for them to get better. Lock in when you have a good opportunity. Do we think rates COULD go lower in the future? YEH. But probably not much better than they are right now...at least not enough to justify the risk of further floating. RATES ARE AGGRESSIVE RIGHT NOW!
Buy the dips and sell the rips people. Dont get caught watching the freight train going by...
Some guidance from MG...
With all that said and with all that in mind, what are the short term implications? As is almost always the case, we have both positive and negative suggestions from data and the charts. Bullet points will probably save time at this point, so those will follow below the two charts here: MBS, Tsy's, and stocks over the past two days followed by MBS, Tsy, and Stocks in a day over day view:
now the daily:
Positive Considerations:
- 10yr Might have resistance at 3.55. We should know in the AM.
- Some of the negative considerations tomorrow come in the afternoon allowing us to avoid intraday reprices that would result specifically from those\
- MBS are still over par and the last time they shot over par, showed the ability to bounce and hang on for a bit before eventually falling
- The S&P finally had a down day and again several technical indicators are calling for a correction. It can't defy the suggestions forever, and even if the bullish trends continue a correction of indeterminate length is close.
Negative Considerations:
- Just as there's positive trend lines on one side, there are negative on the other for the 10ryr. In this case, 3.46 We bounced there yesterdat and haven't spent much time below in the past few months. This level also gets support from the late june and early july bounce that you can see occurring on the solid teal line.
- Even though the S&P finally lost a little, it's exhibiting a similar 3 day price pattern to the prior 3 day price pattern which preceded a rally day.
- PAR-nertia. harder and harder for 4.5's to climb as they extend beyond PAR
- Relying on data and headlines in order to catalyze technical trading patterns. And tomorrow's data is some of the most unfriendly variety we've seen all year: tsy auction ANNOUNCEMENTS, which leave everything to the imagination and can combat no speculation with better than expected results. Just looking at the record of our previous encounters with them would seem to suggest locking in the AM.
All told, there are ways to justify either course of action tomorrow. But in the scope of the last two months, the data ahead compared with current price action is more suggestive of a lock bias. The percentage of the pipeline you choose to lock, as always, will depend on your personal gut-flop strategies. And for those with enough risk tolerance, gains are indeed possible tomorrow.
Good night all...AQ and MG
MBS, TSY, LIBOR QUOTES