Yesterday stocks found early morning optimism in better than expected jobless claims data, but lost that warm and fuzzy feeling when reality set in that Chrysler (and likely GM) would face Chapter 11 Bankruptcy. The Dow hit an intraday high of 8305 but fell precipitously leading up to President Obama's news conference announcing Chrysler would be unable to pay their debts after creditors refused to renegotiate. The Dow closed at 8168...down 17.61 points on the day.

While equity traders were seeking  reason for hopefulness, the 10yr Treasury note yield hesitantly drifted back and forth between 3.10 and 3.17 as fixed income market participants harbored their dissatisfied feelings with the FOMC's lack of attention to the steepening yield curve. Most yield curve watchers were anticipating the Fed would ramp up their open market Treasury purchase program, so when there was no fixed income friendly verbiage in the FOMC statement....positions needed adjusting and new strategies needed to be implemented. This put yield chasers in a technically driven trading posture and created some market movements that were not easily discerned  by an untrained eye (or if you dont have all the tools necessary to know what was moving money).

As stocks searched for economic bottom and the yield curve buyers were forced to face the music.  

What Music?

The drone of the yield curve grinding steeper and the screams of worried MBS buyers fleeing anything EXTENSION RISK related...

Since early April the 10 yr Treasury yield has risen 50bps, yet mortgages remained stable thanks to the block buying powers of the Federal Reserve (yield spreads have tightened). The tighter yield spreads between MBS and TSYs were beginning to draw some none Federal Reserve funded demand to our side of the stack, this augmented funding added liquidity and increased demand side support for mortgage rates. It was a GREAT MONTH FOR MORTGAGES...we essentially strengthened all month while the Treasury market weakened (we were off in our own little world!). Unfortunately this posture was predicated on the assumption that the Federal Reserve would continue to artificially flatten the yield curve via open market purchases. Well...after Wednesday, that "assumption" has been amended. The FOMC's lack of yield curve friendly verbiage put MBS buyers on the defensive.

When benchmark Treasury rates rise, the duration (expected life of cash flows) of "out of the money" (at par or below par) MBS coupons grows longer. The farther out of the money an MBS coupon is... the more it's duration will EXTEND when benchmark rates rise. This occurs because the borrowers backing those MBS pools will have no reason to refinance if their rate is below current market. This means "current coupon" MBS investors will be STUCK in an underperforming asset that is paying less than what the market is currently offering!!! (That is extension risk)

Plain and Simple: If benchmark interest rates move higher, available funds can be reinvesting at current market for a higher yield and more return. Because the holder of MBS coupon can't call the debt  due when interest rates rise (only a borrower has call option on their mortgage), that investor will be stuck in an investment that is UNDERPERFORMING. Hence...real money and levered money will stay away from anything extension risk"rate sheet influential" MBS coupons.

That is why we have seen so much RED lately...blame extension risk for the REPRICES FOR THE WORSE.

Now What?

At this point everyone wants to know WHEN, HOW, and IF the Federal Reserve will flatten the yield curve. Until then...the Federal Reserve will be left to their lonesome to fend off any originator supply offerings...and they will probably be sure to get a good deal when they do buy! This means things could get a little choppy for a time...but, we have faith! This is not  grounds to enter panic mode. Remember: the Fed still has $845 BILLION to keep mortgage rates near month end/beginning MBS SUPPORTIVE EVENTS

Here is a bit of optimism for you regarding volatility in the Treasury market....Yesterday the one day put/call ratio on the 10 yr  was 0.90, compared to 0.37 on Wednesday...this signals sentiments are equalizing in the Treasury market as participants settle into the post FOMC paradigm.

At the moment...

Since 5pm "Going Out" Marks...


FN 4.0 -------->>>> -0-08  to  99-24   from 100-00

FN 4.5 -------->>>> -0-05  to 101-19  from 101-24

FN 5.0 -------->>>> -0-03  to 102-23  from 102-26

FN 5.5 -------->>>> -0-02  to 103-15  from 103-17

FN 6.0 -------->>>> -0-01  to 104-16  from 104-17


GN 4.0 -------->>>> -0-08  to 99-28    from 100-04

GN 4.5 -------->>>> -0-06  to 101-26  from 102-00

GN 5.0 -------->>>> -0-05  to 103-09  from 103-14

GN 5.5 -------->>>> -0-03  to 103-23  from 103-26

GN 6.0 -------->>>> -0-01  to 104-09  from 104-10

2s/10s: 223bps

Dow: -57 points (-0.70%)_ to 8110)

Before you go back to doing whatever you were doing... here is some hopeful perspective. Lenders locked in their profits when MBS prices were at the top of their trend channels. This implies that, regardless of the current MBS market, lenders  have some room to offer aggressive loan pricing. Whether or not they do depends on the health of their pipelines, the amount buckets have been filled, and the behavior of competition.

PS...Welcome to HVCC HELL DAY 1