MBS MORNING: Building Optimism. Cautious of Stock Lever
Noticeable weakness in stocks is adding steam to the TSY rally that began on Friday morning. After retracing a small portion of overnight gains, the 10 yr TSY note is once again testing the early session yield lows (price highs)...
As TSY yields began to tick higher at the 8am open, the price of the "rate sheet influential" FN 4.5 fell 7 ticks (0-06) off the early session 100-10 high, however as TSY yields moved back to the lows of the day, the FN 4.5 made a new price high.
This is a great positive in your eyes as higher MBS prices generally equate to lower mortgage rates....unfortunately this morning's higher MBS prices are a function of lower TSY yields, not building demand side support for current coupon MBS. Meaning....in terms of relative value, MBS are getting outperformed by TSY this AM (yield spreads wider)....keeping us defensive of choppy benchmark yields. (Volatile interest rate markets make for rapildy lengthening and shortening durations and a need for trader's to quickly adjust hedge ratios...which can lead to some choppy MBS price action and the potential for knee jerk reprices for the worse).
Here is a two day look at price action of the FN 4.5...
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PAUSE FOR EDUCATIONAL OPPORTUNITY
Notice how we don't quote MBS prices in basis points?
If you do this, its not your fault....but youre doing it all wrong! Don't worry though, it's not to late to fix this habit...
You are most familiar with basis points because rate sheets are quoted in basis points (bps). However, in the fixed income world prices are generally not quoted in basis points....yields are quoted in basis points.
1 basis point is equal to 1/100 of a percentage point. 100 basis points equal 1.00%. If you say yield rose from 2.00% to 3.00%, then the yield rose 100 basis points.
Mortgages are traded in 32nds or ticks, not 100th's. Let us show you how 32nds relate to rate sheets....
The conversion:
0-01 = 1 tick = 1/32 = 0.03125.
Multiply by 100 to convert to basis points.
1/32 = 3.125 basis points.
If rate sheet pricing was 100% correlated to MBS price fluctuations (which its not), then a 1/32 move higher in MBS prices would imply your rate sheet pricing would improve by 3.125 bps.
For example, if MBS prices are +0-01 from 100-00 to 100-01. Then, assuming rate sheet pricing was 100% correlated to MBS prices(they're not), yield spread premium would rise from 100.000 to 100.031 (rounded from 100.03125)
More conversions...
0-02 = 2 ticks = 2/32 = 0.0625 = 6.25bps
0-03 = 3 ticks = 3/32 = 0.9375 = 9.375 bps
0-04 = 4 ticks = 4/32 = 0.125 = 12.5 bps
0-05 = 5 ticks = 5/32 = 0.15625 = 15.625 bps
0-06 = 6 ticks = 6/32 = 0.1875 = 18.75 bps
0-07 = 7 ticks = 7/32 = 0.21875 = 21.875 bps
0-08 = 8 ticks = 8/32 = 0.250 = 25 bps
More examples:
If MBS prices are +0-04 from 100-00 to 100-04. Then, assuming rate sheet pricing was 100% correlated to MBS prices(they're not), yield spread premium would rise from 100.000 to 100.125
If MBS prices are +0-08 from 100-00 to 100-08. Then, assuming rate sheet pricing was 100% correlated to MBS prices(they're not), yield spread premium would rise from 100.000 to 100.250.
Plain and Simple: MBS prices are quoted in 32nds. Rate sheets are quoted in basis points.
END EDUCATIONAL MOMENT
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More on Cautious Optimism...
The S&P is holding at 980 after a considerable amount of panic selling this morning. The VIX, a read on market volatility, is 3.47 points higher...it hasnt been this high since July 13th. It also appears that bargain buyers have yet to step up to slow the stock sell off as bottom pickers are a bit more nervous to put in a bid while the majority of the market is dumping supply (dont catch falling knife). This is a positive development for the process of sentiment shifting back towards risk aversion....which will lead TSY yields lower as portfolios are allocated towards risk free benchmarks and other "safe" fixed income assets.
Although we are getting more excited about our outlook, we must remain defensive of the stock lever's influence over the yield curve. NO CONFIRMATION of a trend can be taken from one sessions supply/demand technicals...expect TSY profit takers to reflect this skittish sentiment.
Out of the 20 rate sheets we track...the weighted average 30 yr mortgage rate is almost 6 bps lower. Mortgage rates (rate sheets) are better this AM....
Cautiously floating into this inflection point...