MBS AFTERNOON: Post Auction Trade Serves as Reminder
A correction has indeed occurred: several lenders have repriced for the better.
The FN 4.0 is trading +0-05 at 98-24 yielding 4.131% and the FN 4.5 is +0-07 at 101-12 yielding 4.333%. The secondary market current coupon is 4.232%. The CC is +78/10yr TSY and +66/10yr swap.
The post auction recovery rally in benchmark rates was a function of short covering and some fast money buying. This "relief rally" (you'll note sarcasm later in the post) had led the 10yr TSY note all the way down to 3.43%.
I've been hesitant to address this issue while I've watched it slowly unfold, but perhaps now is a good time to raise the red flag. Lackluster demand for the long bond can be viewed from a relatively clear cut point of view: with the economic outlook so uncertain, meaning there are several signs of recovery which are not supported by the underlying fundamentals, specifically the labor market and housing, why in the world would an investor want to loan their money to the government for 30 years?
Doesnt make much sense.
This perspective combined with the market's willingness to let the yield curve continue to steepen makes it glaringly obvious that investors are growing increasingly nervous that benchmark yields will be moving higher in the not so distant future....hence the overwhelming amount of short positions in the frequently traded 10yr note.
Of course, instead of taking such a big picture point of view, one might simply point towards rising demand for riskier, better paying debt investment alternatives such as munis, corporates, and junk bonds. Unfortunately, when rationalizing that trade, I am still led back to the notion that it has been spurred on by the theory that rates in the long end of the yield curve are priced too rich relative to inflation expectations down the road.
WAIT WAIT WAIT...I think its time for me to remind myself of something very important. The one concept that has kept our crystal ball clear during periods of chopatility...
ITS A TRADER'S WORLD. WE'RE STILL LIVING IN IT!!!
How could I forget? So perhaps recent curve steepening has NO implications over the big picture and it's purely a TRADE and nothing more...an opportunity to churn profits. The same way that yields in the short end of the yield curve were forced higher ahead of the FOMC meeting because the market was allegedly concerned that the Fed might hint at a rate hike in the November FOMC statement. HAHA...we all see how that BIG PICTURE perspective turned out...after cresting over 1.00%, the 2yr note is now trading at 0.807%. So the market just forgot about their worries that the Fed was going to raise rates?
No. It was never a real issue.....it was JUST A REASON TO TRADE. It was an excuse to set a position and churn profits....which is exactly what I believe is occurring right now in the long end of the yield curve.
When rates have had reason to rally, short positions in the long end of the curve have been reluctant to let the 10yr make much progress. When rates have had reason to sell...prices fall considerably, the yield curve bear steepens, and yields push higher in a hurry . But then short positions get covered, profits are booked, and the market looks for a new entry point which usually results in a short term visit back to the confines of the range. 10s rally in the short term, then short positions are added, and when the opportunity presents itself, selling takes over, the floor falls out from under us and rates rise again. Then profits are booked and the entire process repeats itself.
This is the same strategy we've seen unfold all summer and most of fall...the only difference is what issue the market is currently pretending to care about....the only difference is whether or not the market is feeling SHORT or LONG!!! The end result: the range trade.
Whether or not the steepener trade has run its course yet is unclear....once the market collectively decides whether to be short or long...that bias will help determine directionality! Then the media will find something else for trader's to pretend to care about....
By the way...throughout the evolution of this "steepener" bias....minimal supply from mortgage originators and ongoing Fed support has sheltered "rate sheet influential" MBS coupon prices. Mortgage rates have completely ignored their benchmarks....