MBS AFTERNOON: Rally Was Just Too Easy
Goood Afternoon. I'm sure everyone is feeling cheery given the MBS market's price appreciations today. Reprices for better were not widespread but we saw a few that looked worthwhile.
After an early session scare, the FN 4.5 returned to its trend channel, eventually closing near session highs. At 3pm book marking (actual close), the FN 4.5 was trading at 100-16. After the bell, month end index buyers came in and pushed prices a bit higher. Once that onslaught of activity was completed, prices made their way back towards 3pm marks.
Meanwhile, heading into the close, stocks positioned themselves at an interesting price point. Failing to break overhead intraday resistance....but at least making it back to 1021.
I have been referring to "month end extensions" all day and no one has asked what the heck I am talking about...I will keep it quick with that in mind.
Portfolio managers compare their returns against those of a benchmark. Fixed income managers who hold MBS in their portfolio measure their specific MBS coupon returns against those of the Barclay's MBS index (and a few others). Part of the performance evaluations require a measure of the duration of their portfolio against the duration of the index.
Duration is the sensitivity of a bond's price to shifts in the yield curve.
At the end of the month, portfolio managers must rebalance their portfolio to match it's duration to the duration of the index. If the duration of the index extends...then portfolio managers must add duration to their portfolio. This can be accomplished by purchasing "rate sheet influential" MBS coupons, which are more sensitive to interest rate changes and have a longer expected life (because of less prepayment risk).
This month, the index extended a "whole bunch"...so at 3pm when the MBS market officially closed for August, portfolio managers began buying longer duration MBS coupons to rebalance their portfolio's sensitivity to interest rate risk. This resulted in higher prices and tighter yield spreads.
Plain and Simple: "Rate sheet influential" MBS coupons got a little extra demand side support from portfolio managers because of the index extension
Onto the outlook....
Today's MBS rally was just too darn easy...speculative buying ahead of month index extension purchases added demand side support, then bid lists (BWIC:bids wanted in competition) benefited from looming prepayment reports. This is a factor of market participants wanting to buy "prepay protected" pools. These are MBS pools which have already proven themselves as stable performers...generally UIC players buy these specified pools. Then of course the Federal Reserve was around the absorb any and all originator offerings (lenders selling rate locks). It was just an easy day...all momentum was positive.
I dont want to say here was no substance to the rally...but there definitely wasnt any monumental shift in sentiment either! With a portion of month end supportive events behind us....the MBS market appears to be back at the mercy of benchmark big brothers (TSYs and swaps). In regards to today's TSY rally, all I will say is stocks were lower all night and all day, and TSY prices rallied higher in extremely LOW VOLUME (seriously it may have been the slowest day of the summer). We put no weight behind today's TSY rally.
I will save the rest for MG to discuss in the close...but for now, let's just say I am not feeling to confident about this rally holding up.