MBS OPEN: Rates Sideways in Range Ahead of Data..
So Far this Morning...
- SHANGHAI + 2.70%, HANG SENG -0.61%, TOPIX -1.58%, NIKKEI -2.31%, CAC 0.43%, DAX +0.06%, FTSE +0.44%
- Roubini says "mother of all carry trades faces inevitable bust"..economic fundamentals don't match optimism in risky assets. READ MORE
- The CIT Group filed for bankruptcy, helping the bond market briefly improve in the the overnight session...however as the firm's failure was priced in on Friday, there was little room for the stock lever to help initiate a continued bid in Treasuries and prices have since gone sideways/are slightly weaker
- Best read in 18 months on Chinese Manufacturing also didnt help the US bond market. READ MORE
The dollar index is 0.12% weaker and S&P futures are slightly better but mostly sideways. Waiting for 10am data....
10yr Treasury futures prices spike higher at open last night, but quickly lose steam before drifting sideways in a tight overnight range.Waiting for 10am data...
In the cash market, Treasury yields traded up to 3.42% then held in a tight range....waiting for 10am data.
The FN 4.0 is -0-06 at 98-15 yielding 4.159%. The FN 4.5 is -0-05 at 101-02 yielding 4.371%. The secondary market current coupon is 4.297%. The current coupon yield is 88bps/10yr TSY yield and 70bps/10yr swap rate. The FN 4.5 is +96/10yr TSY and +79/10yr swap rate. Again...waiting for 10am data.
Here is the FN 4.5...
The beginning of the month is generally a supportive time for the MBS market. These "supportive events" dont necessarily imply positive price directionality, the effects of the "supportive events" are noted in the performance of "rate sheet influential" MBS coupons is better witnessed in the the performance of pass through MBS coupons vs. the performace of their benchmark big brothers.
Plain and Simple: MBS coupon yields either fall more than their benchmark's yield or MBS coupon yields rise less than their benchmark's yield.
Supportive Event #1: Prepay Reinvestments
Each month MBS analysts and traders spend a considerable amount of time forecasting borrower refinance behavior. Borrower refinance behavior (or any action associated with paying off your mortgage) is revealed through MBS portfolio prepayment speeds. Prepayment speeds are THE key determinant in the valuation function of MBS. If prepays increase or decrease more than expected it can drastically alter the value of an MBS holder's portfolio.
At the beginning of every month, the principal prepayments from the previous month are reported. The "paid off" loan principal (of the mortgages you own) is deposited in the portfolio holders account. This is straight cold cash...funds that can be reinvested!!! Depending on the interest rate environment those funds might be reinvested in new MBS....which adds funds to the demand side of the MBS market.
Supportive Event # 2: Month End Index Extensions
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).
Plain and Simple: "Rate sheet influential" MBS coupons got a little extra demand side support from portfolio managers because of the index extensions
Supportive Event #3: Attention to Settlement
In the TBA MBS market, at the time of the trade, the buyer and seller agree to the type of MBS (FN,FRE,GN), the coupon, the price, and size of commitment...they do not however provide the specific pool details of the trade. Trade settlement dates are preannounced every month by SIFMA. Two days before settlement date sellers are required to notify (notification day) buyers of the specific details of the pool that the buyer agreed to purchase from the seller. The pool details are required to meet specific standards that were agreed upon at time of trade. Two days later the trade is settled!
These events occur at the beginning of every month. As the calendar grows closer to settlement date MBS market participants begin to pay much closer attention to the TBA MBS market because a profitable opportunity may arise. This takes fixed income investors attention off of other relative value securities and focuses it more intensely on mortgage world!!!
Supportive Event #4: Less Interest Rate Volatility
When pricing the value of a fixed income instrument, one of the most important metrics is your expectations for the future of interest rates...or the expected volatility of interest rates over the time period in which you expect to hold a specific fixed income investment.
Future interest rates are not impossible to predict, but are extremely difficult to estimate with a high degree of accuracy. Predicting future mortgage cash flows not only depends the expected behavior of borrower refinances and new home buying trends (see explanation above)....it depends on the anticipated volatility of benchmark yields (TSYs).
Investopedia's Plain and Simple: Volatility refers to the amount of uncertainty or risk about the size of changes in a security's value. A higher volatility means that a security's value can potentially be spread out over a larger range of values. This means that the price of the security can change dramatically over a short time period in either direction. A lower volatility means that a security's value does not fluctuate dramatically, but changes in value at a steady pace over a period of time.
What does lower interest rate volatility have to do with the beginning of the month?
The US Government has scheduled the release of its Employment Situation Report (Nonfarm Payrolls) on the first Friday of every month. The entire marketplace is sensitive to changes in the labor market. The importance of this report can have major effects on trading positions, therefore in effort to protect portfolios from the possibility of volatile price swings, market participants generally set a neutral position or move to the sidelines to wait out the marketplaces reaction to the data. The Employment Report helps reduce the implied volatility of interest rates!
Furthermore because market's are relatively calmer, it is cheaper to hedge your MBS positions with options contracts. All in all lower implied volatility has a positive effect on the valuation of "rate sheet influential" MBS coupons....great timing considering the previous supportive events.
These events combined are supportive of the MBS market....