MBS MORNING: Attempting To Hold Range As Stocks Rally
As we discussed earlier, the AM data crushed the bond market sending MBS from 100-26 to 100-08. For those without calculators or excellent mental math backgrounds, that's a 14 tick drop--about half a point. But MBS and tsy's have both recovered to rest somewhere in the range implied by yesterday's momentum even though that momentum was mostly sideways. For MBS, that brings us back to 100-18 whereas tsy's are chopping around the 3.45 yield level in the 10 yr.
You can see on the chart below a firm(ish) ceiling starting to take shape at 100-18 in MBS. Additionally, there are two recent bounces at 100-12 on the downside. Considering that yesterday's chopitility finally began honing in on the 100-14 level, this would be a more than acceptable level to hold in lieu of the equities freight train. In fact, stability in this range through the day would be exactly what we need in order to cash in on some "volatility hedge" locks that we'd probably advise by the end of the day assuming rate sheets reflect MBS prices.
At these levels, MBS are again outperforming tsy benchmarks. the 100-18 price would in fact be up 3 ticks on the day whereas tsy's at 3.46 would be down 7 ticks. Chalk up the MBS McLovin' to the familiar tune of Fed buying outweighing supply offerings by 2:1. Most of the stack is flat with the "down in coupon" play in 4.0's offering 4-5 ticks of compression. In English you ask? "Down in coupon" meaning that lower coupons are gaining in price more than higher coupons. This is somewhat analogous to "flattening" in the yield curve. "Compression" refers to the RELATIVE price levels between coupons. Quite simply, the CLOSER coupons become in price, the higher the level of compression. At the lower ends of the stack, such as 4.0's, compression varies greatly due to the oh-so-important forces of convexity.
Helping compression on the higher end of the stack is a phenomenon that we don't usually discuss. The main reason for this is that the higher end of the stack does little, if anything, to inform rate sheets--thus the repetition of our coined term: "rate sheet influential" MBS. But this component of the upper stack is gaining such an acceptance that it deserves mention in any conversation on the comparitive outperformance of the lower stack. The point? Prepayment and/or speed-related fears currently pervade the higher coupons that the trading world perceives as "credit impaired." In other words, whether it's because borrowers who can "only" qualify for those higher rates are more likely to seek refinancing sooner, or because loans with those rates are more likely to be part of some sort of modification, foreclosure, short sale, etc..., investors perceive extra risk that the "call option" will be exercised sooner than otherwise anticipated.
When loans with a price OVER 100-00 are refinanced or otherwise retired due to any of the above-mentioned reasons, investors make less money. The sooner this happens, the more money they lose. So with the ostensible abundance of modification assistance, and the existence of lower market rates, investors are planning on faster than expected prepayments which clearly suggest offering lower prices for higher coupons. Where that "magic level" happens to be where prices are low enough for investors to make money, but high enough for sellers to part with them is one of the eternal mysteries of the MBS market and is what seperates the well-paid, from the very well paid. That's the reason that prepayment models are so closely guarded and so infrequently discussed. "The Colonel's Secret Recipe" if you will.
Back to business for a sentence or two... Waters are calm for the moment. Tsy futures are still trading over critical support offered both by recent lows and Volume Weighted Average Prices (VWAP). All this despite the stock rally. As long as tsy's remain stable and MBS hold in or around the green, I don't see any problems floating into this afternoon, but I'd certainly be comparing MBS price levels over YSP's against their recent performances. If lenders seem like they're being generous enough on rate sheets given a par and a half-ish price level, hedging against some of the rate market chopitility might not be a bad idea later today, especially ahead of tsy supply announcements which traditionally "ain't friendly."