MBS have found their second wind after taking a bit of a beating this morning. Well, the losses this morning were more likely an extension of those from yesterday as the data has been more or less on our side this morning.
The Consumer sentiment reading came in at 69.5, lower than the expectation of 70.0. The current analysts forecasts for all the various consumer reports are very low to begin with these days, so when we keep dipping below expectations it's generally good news for MBS.
To top it off was (finally) some tame inflation data from earlier in the morning. The market has seemed to react well to that. Ever since 8:30 AM eastern, the MBS curve has been on a tear. We've gained a whopping 14/32nds from the lows of the morning. That's an uncommon swing to occur so early in the morning, so plan on lenders pricing conservatively until these gains are solidified.
As such, floating is the name of the game for now. If lenders already released pricing, they will be repricing for the better even if MBS simply hold their current levels for a few hours. Lenders that release pricing now or soon will likely not give us "all the love" until a few hours from now as well.
From a technical standpoint it's tough to tell if the trough that we've experienced from the highs last week falls in line with the "bouncing ball" cycle we've been seeing. My opinion is a bit risky, but if you can afford the risk, it may pay off. The spread of MBS to the 10 year treasury is still historically very high. It will remain that way until the safety of MBS is reestablished. If Lehman Brothers proves it's not another Bear Stearns, a goal that is assisted by news such as today's CitiGroup Upgrade, that is the sort of headline that could help this safety perception return. Another beneficial factor is Uncle Ben's willingness to participate in MBS. A lot of our spread gap between the treasuries would have already returned if he had made this move 4 or 5 months ago and the market had a better chance to understand its implications. But just like everything in the bond market, minimizing risk is the name of the game. So radical changes are always forced to prove themselves out for a reasonable period of time.
Nonetheless, you know and I know that the quality and safety of mortgage paper is absolutely returning to the market. For originators, the changes have been drastic and brutally apparent with changes in underwriting guidelines. That increased stringency absolutely will filter down to decreased defaults. But, like everything, this will not happen overnight, and will be mitigated by the "old" 640 mid score, 100% stated income, Non-Owner MBS's that are still scaring investors (as well they should). So it's a battle of good versus evil. No doubt that Darth Vader still has some more fight left in him, but we know that Luke's Jedi powers are growing stronger, especially when old Ben
Kenobie Bernanke steps in to help.
So I know we rarely, if ever, discuss long term outlooks. In this volatile market, taking a stance on such things is a fool's errand. Nonetheless, I'll share it with you and take it as you will:
I disagree with the technical read on the data that suggests a major resistance level that we've failed to break through on two rallies in the last month. I agree that it appears to be a ceiling (you know, the ceiling that keeps 30 year fixed rates from dropping below 5.25-5.375 PAR), but instead, I believe it's just a few "blips of the throttle" before we begin to accelerate.
Look, if this were 2003 (which it's not, and never will be in terms of spread), a 10 year treasury yield in the 3.5 range coincides with a 5.5% MBS price of well over 103-00 and closer to 104-00!! Yes, and we're at 100-18 right now with the dame treasury levels. So that's a difference of 3 points of YSP that you would have had 5 years ago for the same interest rate. That type of price on a 5.5% coupon would likely push PAR towards the 4.625-4.75 range.
Sure, we will not necessarily regain our old spread levels versus the 10 year, BUT we will absolutely close the gap as the safety returns (if the safety continues to return. If the Fed goes bankrupt, we may be in trouble). So, to come to the point, assuming that recent events indicate a trend of stabilization in MBS risk, and assuming a historically average level of headline risk, MBS has room to improve past this "ceiling of resistance." The things we have to watch out for that render this opinion useless are headlines that damage the risk perception of MBS (or as far as investors are concerned, the net yield on their MBS money). If those headlines come to pass, of course we have to assess them as they come and go more conservatively. But I do feel that the ongoing biography of Lehman Brothers will be a major factor. They are the largest participant in the MBS market. Right now we have some people calling their stability into question, and others edifying them. How these opinions play out will be very impactful to MBS stability perception
So take that for what you will. There's absolutely no way to predict rates in the mid term in this market. I can guarantee that they will go up eventually, but the question is whether or not they will come down past this resistance level we're getting with a 5.5% MBS around 101-00. Apply your own lens to the data and draw your own conclusions, but in short, that's my argument for a mid term float (which of course is immediately retracted if we get any more headline bombs such as the Ambac and MBIA stuff from earlier this year). So stay vigilant and optimistic. Float through today and assess rates at your lock cutoff. If you can't afford to take the risk of losing that rate, lock it. But if you have a certain degree of risk tolerance or room to fall without losing the deal, I think floating into next week could pay off. Let's revisit that thought at the end of business today though, or over the weekend.