MBS LUNCH: Much Needed Spread Widening As Treasuries Outperform

4.5 MBS briefly crested 102-00 earlier today, just before noon, and have since fallen to 101-26.  More recently, prices hovered closer to 101-30 making current levels good for about a 4 tick fall.  In the AM post, we said: "if the bond market can create additional momentum while maintaining its flatness, it would allow for some much-needed spread widening with limited to no negative effect on MBS prices."

Bond market improved from AM?  Check...

Flatness maintained?  Check...

Spread Widening?  Check...

Limited to No negative effect on MBS prices?  Check...

Don't be too concerned with the recent price loss...  Standard fare for MBS and Tsy's has been a wider range in the AM, narrowing into the close.  Put it this way: we'll let you know ASAP if we move much below 101-26.  Of additional comfort, is the fact that 101-26 is right in the thick of the AM price action.  In that sense nothing is so much change from the AM.

However, notice that the tsy's encountered resistance at 3.36 as they made their way back down from high yields.  In the AM, that lined up with 100-26 in MBS.  But now with MBS at those levels again, tsy's are 2-3 bps lower in yield.  That's a roundabout way of providing evidence of the spread widening.  It should be easy for all to see considering that tsy's are positive on the day while MBS remain slightly negative.  Barring some crazy happenings in the world of prepayment speeds, that's almost always going to be a recipe for widening...

Spreads are a bit counter-intuitive for loan originators in the sense that "weakness" is not always a bad thing.  Sure, if we were historically wide in spread and then a long and gradual tightening spree would be welcomed (2009 anyone?).  But say 2009 is drawing to a close and MBS spreads have consistently had their world rocked by the Fed...  Then you start seeing MG and AQ talking more and more about spreads being tight to the point of resisting further tightening.

The widening is good in this case because to whatever extent it occurs, it builds back in some room for spreads to tighten in the future (potentially!).  If things widen enough, before you know it, MBS start to look like a bargain buy again in the context of relative value (ROI vs. safer, lower yielding tsy's for instance).  In other words, if spreads are too tight, MBS are too close in yield to tsy's to sustain much demand (unless you have a fed!  oh!  I get it!  Maybe THAT's the big reason spreads have tightened so much after being at all time wides in 2008...) 

But if spreads move WIDER, it means MBS yields are rising compared to tsy yields.  The more that happens, the more enticed investors might be to earn better and better yields on their FI, hence the "bargain buy."  The term "relative value" simply means the value of an MBS investment versus a comparable tsy investment (comparable in terms of duration).  The whole notion of widening being good for MBS and merely ACCEPTABLE for the originator, is predicated on the assumption that tsy's have to be rallying.  Because if spreads are widening on already rising tsy yields, we have a serious rate sheet problem in mortgage land....

But thankfully, that's not the case at the moment...  In fact, tsy's have been on a massive tear overall since the end of October, a fact illustrated well with the futures chart below. 

(whew...  all that typing and still holding over 101-26.  so again, barring a meaningful move below that, we should be on cruise control into the close)