As expected, rates continue to move higher this week.
- FNMA 6.0% Coupon ........... -- 07/32nds
- FNMA 5.5% Coupon ........... -- 12/32nds
This will equate to an increase of .25-.375 discount cost on today's rate sheets.
What might seem strange is that there are no economic reports or shocking items of headline news that are pushing rates higher. Even stocks are moving lower, down over 100 pts currently. So what gives? You may guess it's our old nemesis inflation, and you'd be mostly right. Gold and Oil stay very high while the dollar is very low.
Bonds hate inflation true, but why is the 10 year note not taking nearly the beating that MBS's are? That's a much tougher question. The answer that seems to be most accessible is that traders are concerned with the credit quality of MBS. That being the case, they view the US treasuries as safer investments for their fixed income needs. So they buy more of them compared to MBS which increases their price compared to MBS. I'm not saying that Treasuries' prices are increasing this morning, just that the gap between treasuries and MBS is widening.
It's no wonder this is occurring over the last year with the state of the mortgage market. Who wouldn't feel less confident buying securities that are backed by shakier assets than they thought? But the gap has gotten too wide in my view. Traders are hedging their bets that "mortgage mess" will trickle up into agency paper to greater degree than it already has.
For those that need an explanation of that sentence, here goes: When I talk about MBS, I'm talking about Fannie Mae, Freddie Mac, and Ginnie Mae MBS, collectively "the agencies." Paper = debt obligation. And as far as the "trickling up" phenomenon, I'm referencing the fact that there are many more types of MBS that are backed by sub-prime and Alt-A mortgages. If you have a pulse, you know subprime and Alt-A, well, they're not doing so good. So it's a reasonable conclusion that traders might consider the poor performance in those sectors to signal a potentially worse than expected performance in the agency sector. So MBS gets less attractive and traders prefer treasuries.
This is a good thing in my mind. Anyone on ground level knows that agencies are taking steps to insure the credit quality of their issuances stays intact. It's only a matter of time before market perception cools down a little bit and the quality of MBS comes back into the market. With the 10 year note where it is now, that represents such an unbelievable buying opportunity for MBS. If we had the quality perception of 3 years ago, rates would be getting close to 4% at this point!!!
I'm not saying this is going to happen any time soon, but as long as Fannie and Freddie keep making it nearly impossible for originators to get loans approved, the credit quality of MBS will stay the same or improve.
On a final note, with fixed income and stocks down on the same day, you know traders are moving money out of the market in preparation for the rest of the week's wild ride. As I said last week and yesterday, the technical trend calls for higher rates this week, which has proven out nicely yesterday and today. As far as the parabola that bond prices follow when they are on the move, it usually takes a bit more than a week for it to turn around. In fact, we could go even higher. What we can hope for though, as we've talked about quite a bit, is significantly worse than expected economic data. It seems that, even in the face of inflation, traders will buy MBS when the data is bad enough. So Friday, with the utterly important employment situation is a day to watch. We may have a little "back and forth" in bond prices this week and next, but in general I expect them to trend down a bit longer before coming back up. This means short term lock, medium term float.
But as always, I encourage you to make your own analysis of the situation. If you think inflation is a nemesis that cannot be defeated, you're a locker. If you think the economic reports will be dismal enough to obviate inflation concerns, float it. Be warned that demand for MBS is weak currently. Volume is low which makes volatility VERY high (because one trade can have more of an impact on prices). Stay tuned...