MBS AFTERNOON: Volatility Dying Down As Bonds Improve
Following the FOMC announcement, which was the quintessence of "as expected," volatility understandably ticked up. Stocks moved both higher and lower in an expanding range whereas fixed income mostly worsened in an expanding range. MBS capitalized on the weakness with further tightening.
For reference to our ongoing tracking of the current coupon yield and its spread to various benchmarks, the MBS current coupon rose slightly to 4.352. This TIGHTENED the spread to the 10yr from around 84 bps to 82.75 bps. That's very tight stuff, and the weakening in fixed income was likely the only environment that would have allowed tightening from the already tight 84 bps. In general, MBS yields are more likely to tighten into selling and widen into improvments.
But the 10yr isn't the only benchmark against one would measure the value of MBS. The 5yr tsy isn't hurting nearly as much as the longer duration portions of the yield curve. This is exactly why we discussed the yield curve last night and how the different potential outcomes of today's fed meeting could affect it. Because there was no hint of an increase to short term rates, the shorter end of the curve has flourished by comparison. In fact, the 2yr note is POSITVE on the day versus the 30yr bond which is down over a point!.
So measuring MBS CC spreads to the 5yr treasury yields (no pun intended) a different result. After hovering around 196.5bps this AM, the spread is about 2 bps wider at 198.4. These aren't MAJOR shifts in spread, but it speaks to both the short end of curve's potentially aggressive sugar high (2yr ntoes are under .90!!!) and perhaps a bit to the level of insulation of the MBS stack (whether things are moving higher or lower, MBS are the tortoise to tsy's hare).
What does it all mean for you? Nothing... I just like to hear myself talk. No, but seriously folks... Same sentiments apply... Spreads remain extremely unlikely to tighten into anything other than a sell-off. So when and if gains come in fixed income, MBS are likely to be slower than tsy's. And there's a risk (once MBS traders have a chance to perceive 82bps as "too rich" that even an unchanged yield curve could see some MBS selling.
As far as the prospects for improvements today and the rest of the week, the charts are suggesting something as we zoom in to the tick by tick trade following the FOMC announcement....
The "this" from the chart above could be one of a number of things, not the least of which that it looks like interday technical resistance to further losses. But the 3.56 (ish) yield level should start ringing some bells... Remember when we were in that firm range forever and ever that never went above 3.48...? And then a day before last week's auctions we broke out of the range? And remember how we told you that the sky wasn't falling yet and not to consider this a break of the range even though yields are higher than 3.5? Let's expand the time frame to capture that recent epoch in the fixed income soap opera.
So it's not one of those EERILY PERFECT yield levels that gives us the perfectly horizontal resistance, BUT both the morning yield levels from Monday and Tuesday are right on the mark, as well as the 3pm closing marks from monday. So although yields briefly moved higher two weeks ago than they did today, the modality of those highs suggests it's safe to consider the 3.56 as significant a resistance level as any...
And so it is that "the bottom is in" for the day. Who remembers "base camp" and the "icy cliffs...?" 3.5 is like the long established base camp, but this 3.56 level is proving itself to be highly analogous to those icy cliffs of bygone MBS analogies... The market has been "selling the rumor and buying the truth." In other words, short positions about as we now wait for NFP on Friday.
It's OK TO SEE YIELDS BACK UP THIS MUCH! Even a completely "as expected" print on NFP helps to unwind some of those shorts and suggest that the 10yr yield, at the very least, goes back under the 3.5 level. That could happen sooner than later, especially if history is any guide (2 tuesday's ago, yields fell right back into the range after Monday's super spike). Additionally, right about now is the time of day where stocks start their sell-off into what will hopefully be the lows by the end of the day. Reason being? A series of LOWER HIGHS is suggesting a failure of the stock market to rally on the FOMC meeting...
But this is a temporary victory that promises nothing for tomorrow and Friday... You'll probably see another round of yield concession ahead of NFP. That means that capturing improved pricing between now and then could be tricky... Best reward potential (if there IS a reward) would have to wait until Friday afternoon at this point, and even then would only reach it's potential with a unchanged to better MBS on Monday.
That's a lot of risk to take in, so Gut-Flop accordingly, and let the TONE set by the NFP be your guide... More uncertainty ahead? bonds like it... NFP bolsters recovery sentiment? Bonds don't like it so much, but even then might not experience excessive losses if the pre-NFP concession levels are sufficient to account for reality.
Bottom line, some weakness was, is, and will continue for a short time to be PRICED IN. If that's the amount of weakness we see, we go relatively unchanged. Anything "as expected" or better, and the door's open for us to make up some ground (treasuries first of course... MBS is quite the gentleman...).