MBS LUNCH: Reprices for the Better Reported
The 10yr TSY note continues to extend yesterday's range (wait and see mode. READ MBS OPEN).....
Meanwhile...."rate sheet influential" MBS coupons continue to out-peform their benchmark big brothers.
In a thinly traded market, the FN 4.0 is +0-08 at 98-14 yielding 4.162% and the FN 4.5 is +0-06 at 101-02 yielding 4.371%. The secondary market current coupon is 4.298%. The current coupon yield is +76/10yr TSY and +60/10yr SWAP.
As you can see in the chart below, FN 4.5 prices have recovered all their pre/post-FOMC price losses.
Update on the shape of the yield curve. 2s/10s are steeper again! Now at 264 basis points....
If you are wondering...isn't it odd that the yield curve is steeper and "rate sheet influential" MBS coupon yields continue to outperform their benchmarks?
That would be a good observation...
It's a function of MINIMAL SUPPLY of production MBS coupons in the TBA market, settlement, and the prepay report we will get tonight.
1. The Fed has bought up most of the new loan production.
2. Many accounts are SHORT heading into settlement, these short positions need to be covered.
Don't confuse being short bonds with a SHORT TRADING POSITION like you would have on a Treasury futures contract. When I say short I mean a dealer sold MBS coupons to fulfill the needs of their account, but they didnt actually own the MBS coupon they just sold. This is not a speculative SHORTING, this is a function of the TBA MBS market mechanism.
In the TBA MBS market, at the time a trade is made, buyers and sellers agree to a few specific terms like what coupon, the issuing agency (Fannie, Freddie, Ginnie), the size of trade, and a buy/sell price. The actual pools of loans are NOT exchanged when market participants make this commitment.
Instead, the MBS buyer and the seller make an agreement to complete their transaction at a later date. MBS trading settles once a month. In the MBS market this date is pre-determined, it is called SETTLEMENT DATE (clever name huh?).
Two days before the pre-scheduled settlement date, the MBS seller "notifies" the MBS buyer of the specific pools they intend to deliver to satisfy the previously agreed upon terms of trade. The MBS buyer reviews the loan information to ensure the seller is fulfilling the standard requirements of the trade agreement. Then, two days later on settlement date, funds are wired to the MBS seller and the MBS buyer's account is credited the corresponding mortgage-backed securities.
The TBA trading mechanism plays a very important role in the generation of mortgage rates. The TBA market allows originators to make "forward commitments" before the loans in their pipeline are actually closed...just like loan officers lock in interest rates before the loan goes to closing.
For both the mortgage bank and the loan officer, this function serves as a hedge. It protect their pipelines from interest rate risk (rates getting higher and their loans not being worth as much). If mortgage bankers were forced to lock in their rates after closing...they would likely add in a large "interest rate risk" premium to rate sheets in an effort to protect themselves from shifts in the yield curve.
3. The prepay report is due tonight, to protect cash flows from unexpected prepayments, accounts buy coupons closer to 100-00.
So, the lack of supply, open short positions combined the looming settlement date, and the prepay report has created huge demand for rate sheet influential MBS coupons....hence why spreads are tighter even as the yield curve steepens.
REPRICES FOR THE BETTER HAVE BEEN REPORTED
You have to think this spread tightening/outpeformance will end in the near future.