What's the Trader's Edge?

This will be the name of a new section of the MBS blog when we move to deliver our new set of content.  We have been fortunate enough to create a relationship with a Senior MBS analyst/active MBS trader/and formerly heavy MBS trader at a major firm on the street.  Though he must remain anonymous for obvious reasons, we will be able to benefit from his daily contributions in this "Trader's Edge" section.  Perhaps the "trader's edge" is a moniker for a symbolic sword which he uses the slice though the more esoteric knowledge of the MBS market.  If the "edge" is a sword, that must make him the MBS samurai, or even an MBS-ninja.  Whatever the case, I'm sure we'll have a contest to name him as the new system becomes a reality.  For now, we'll go with ninja.

The preliminary conversation we've been having with the MBS ninja has yielded the following thoughts.

- both of us agreed that it was a noticeable omission for the fed to have not made mention of its commitment to take any steps necessary to combat either inflation or slow growth.

- both of us thought it was significant that the fed seems to be more positive towards growth and less positive towards inflation.

- both of us thought it was significant that the fed's long term outlook was for inflation to moderate.

- both of us are surprised that the MBS market has been as resilient as it has considering the above concerns seemingly weighted in favor of increasing growth and high uncertainty about inflation.

- both of us agree that this resiliency in the face of the inflation verbiage is a very good sign for the rest of the day and week.  But beyond these topics where both of us have thoughts, he has additional perspective that only an analyst and trader could bring:

  1. The lower "stack" of MBS coupons (4.5's-5.5's) will track much more with treasuries right now.  Lo and behold, this has been the case, and should continue to be the case
  2. The lower stack should be a much more enticing buy right now compared to the "current coupon" (current coupon meaning the coupon rate at which a majority of mortgage pools are being sold.  Currently this is the 6.0 coupon).  Lo and behold, the lower stack is faring extremely well with 5.0's picking up HEAVY gains since the FOMC announcement
  3. If Prices hold, Asia could come in big tonight with buying.  The ninja mentions that Asia, and especially Japan "tends to buy at PAR-ish coupons."  This suggests that the 6.0 will find support later today as traders are well aware that Asia could drive current coupon prices up.  (PAR-ish, simply refers to coupons that are closest to a 100-00 price.  In this case, the 6.0 is obviously the only coupon near PAR.  If we were more straddling par between two coupons, the buying could be more split between the two, but the 5.5% coupon may be slightly too low of a price to entice the same level of buying.)
  4. The 2's/10's curve was initially flattening after the FOMC announcement.  This would be bad news for MBS since it indicates that short term money is the soup du jour, so buying interest in MBS would move towards the higher stack (6.5's+) as the higher the coupon, the faster the speeds of repayments.  Indeed, this was the case immediately following the announcement.  But the 2's/10's has since gone on a "steepener" which has brought buying interest back to the lower stacks and picked up some PAR buying on the way down.
  5. The average life of a 6.0 FNMA MBS right now is about 5 years, so its chief competition and basis for comparison would be the 5 year treasury, whereas the commonly held belief is that the 10 year treasury is the better benchmark.  So if we see the 5 year picking up steam, it is also an indicator for the 6.0 to follow.  As traders buy 5 year UST's, the 6.0 MBS's left behind begin to look like better and better of an investment.  Then the buying interest picks up.  So as the 5 year UST came up in price over the last 20 minutes, the 6.0 has followed and is now at 100-07.
  6. Banks (as in domestic institutional banks), according to their charter do not buy or hold any coupons at "a premium," because they can't report value for anything over PAR on their books.  So this creates resistance to the 6.0 moving higher as banks have to start dumping their 6.0's as they rise over PAR.  So the fact that 6.0's have held steady and improved (likely with "sleepy" buying from Asia), it's a positive indicator for 6.0's overnight and tomorrow morning, and an excellent indicator for 5.0's and 5.5's. 

I'm sure your eyes are just as glazed over as ours, but rest assured, more "cliff notes" for our ninja will be available by and by.  For now, I'm sure you can see that this Trader's Edge is a powerful weapon indeed.

Stay tuned, and sit tight for more improvement in the MBS market.