MBS CLOSE: Tumultuous Week Sees MBS Gain, Tsy's Lose

In a week that promised to be eventful, MBS played the volatility role with the rest of the market, but left it's benchmark's in the dust when all was said and done.  The measure of the secondary MBS market that takes into consideration the prepayment speed weighted yields as well as the production mix of MBS volume and expresses that notional yield at parity fell to 4.258 (that's secondary market current coupon, btw...).

With the 10yr yield ringing the 3.5 bell right on the nose, that brought spreads between MBS and Tsy's to an eye-wateringly tight 75.9bps!  They started the week at an already tight 87.9bps...  Though I could try, I'm not sure there's much I could do to convey just how tight these spreads are... Well, I guess a chart might do...

This is the current coupon spread versus the blended yield of the 5 and 10yr tsy.  Over time, that 7.5 year notional yield is a better approximation than simply going with the 5 or 10 yr tsy exclusively (or the 7yr tsy for that matter).  The chart shows that although we're not at historical lows, we are pretty much in line with the lowest points of the last 10 yrs.  Now, if the competition were to see which era of MBS spread tightening achieved such tight yield THE FASTEST, there would be no contest. 

The pace at which Fed participation in the MBS market has tightened spreads is not only staggering, but abundantly clear from the chart above.  The type of noise that the line encounters in 2009 tends to be what the graphs of financial instruments do right before they're about to do "something else."  That much is easy to assume.  The challenge comes in determining what that "something else" will be.  We've said over the past few days that spreads are not likely to go much tighter in light of the impending fed exit. 

And although today proved we can go tighter, tradeflow factors (such as the fed being a seller of ZERO MBS this week) introduced compounding factors.  With settlement approaching next week and this traditionally supportive week behind us, MBS would have a much tougher time tightening from 80 to 70 bps than they did from 90 to 80.  This may be nothing more than a point of curiosity, but part of the reason I continue to call attention to it is to temper the expectations of further upside potential against the backdrop of a stagnant treasury market.

The other reason to call attention to it would be to lay the foundation that explains why MBS are improved in the chart below, whereas tsy yields rose on the week.

Both sides of the market had decent days today, with MBS outperforming slightly, and thus adding on to their spread tightening for the week.  NFP may be talked about as a catalyst for the gains, but as I said earlier today, it might as well have not even been reported...  Considering the "logical extension of previous movement" seen in the chart above and even more significantly in the chart below, and asking that you forgive the hours of 8AM to 10AM for some nominal post-NFP volatility, it's hard to argue otherwise:

It's interesting to note the volume decreasing in waves throughout the day as the wildly swinging price pendulums slowly return to rest at their previous midpoints.  I ask you <with an almost sarcastic indignance> is it not incredibly interesting that after all was said and done this week that 10yr's flatlined at 3.5, going out the door at exactly 3.499? 

Rhetorical questions aside, it creates a bit of dichotomy in the long-view that sees MBS holding slightly more positive and/or bullish ground than tsys.  Whereas it's hard to infer ranges in the short term future based on the tsy portion of the chart below, MBS have put on a clinic in text-book upward movement within technical trend channels... 

MBS look like they're without a care in the world, happily rallying with plenty of support from progressively higher technical levels...  And meanwhile, tsy's come to rest on the fence of all fences at 3.5....  The discussion to this point concerning spreads and MBS's eventual forced capitulation to the yield curve's whims is the first clue that "nothing lasts forever" in terms of MBS market Euphoria.  Clue 2 is much more matter of fact, and that is that next week, the price of the most current 4.5 MBS will drop something to the tune of 11 ticks merely as a result of the November coupon settlement and the torch being passed to the December coupon. 

That, in and of itself, throws off the technical significance to some extent.  But as the actual "drop" approaches, we'll be closely watching to see if we can eke out the liklihood that it will have prices "land" on one of our friendly neighborhood trendlines.  Even if that happens, I'm in favor of "broader macro" as a driver of fixed income at the moment over "technical price movements within a range."  The caveat is that "broader macro" would actually have to SAY SOMETHING next week, which it hasn't done for quite some time.

And there's that theme again...  range bound and waiting for guidance?  You betcha!  Stocks cast the vote as well having failed to crest 1100 in the S and P or 10100 in the Dow...  That's too heady a level to even discuss!  In fact, the bigger concern may be their failure to rally through the previous rally wave in late September as you can see on the chart below... 

If some sideways movement ensues without the S and P getting much higher, it will have more than a few bright-eyed, bushy tailed CNBC anchors reading teleprompters with something to the effect of : "Here now from _________ is _________ to tell us about the "head and shoulders" that is potentially forming in the S and P.  Hi ________, so tell us, what is this strange and mysterious thing you call "head and shoulders?"

That's purely speculation though, and we're certainly not suggesting it as anything other than one of many potential outcomes (perhaps one of our favorites though).  Monday brings no econ data, and Tuesday is also sparse as far as scheduled Econ is concerned.  But there is plenty of Fed Speak as well as the 3yr auction on Monday and the 10yr auction on Tuesday.  Market movers for sure...  Wednesday is Veterans day and while stocks are open, bond markets are not.  The data goes into it's normal weekly routine on Thursday and ends with a mid-tier round up of econ on Friday with Consumer Sentiment, international trade, and import/export prices in addition to some fed-speak courtesy of Chuck Evans.

So it's not that we've slipped the MBS crystal ball back into it's faux velvet drawstring bag and placed it back on the shelf for the weekend.  It's just that we enter the week as we have so many times in recent months: with no clear indication of direction and waiting for a long overdue sign...  That said, if we were going to get into the "point / counterpoint" style of discussing eventualities in the week to come, we'd likely note that, with rare exception, auction ANNOUNCEMENT weeks have been worse for bonds than the auction weeks themselves.  That might require the actual results of said auctions to be supportive, but even if they're merely "not negative," we might live to lock another day in this heady age of the sub-5% mortgage...

Have a good weekend.