MBS AFTERNOON: Rates Move Outside the Range

Last week the 10yr TSY note bounced around between 3.32% and 3.37%. Early on this week, that range was broken as 10yr note yields tested 3.42%. However, as positional support remained in tact,  higher yields and lower prices drew out bargain buyers which quickly pushed yields back into last week's range. This is considered a range breakdown correction. Spurred on by momentum, traders pushed yields back to 3.32%, the lower limits of last week's range. This highly trafficked pivot point, which failed to break three times last week, was broken today.

The 10yr TSY note is currently trading +0-11 at 100-30 yielding 3.264%. The question is now...will the range breakout fail just as the range breakdown did earlier this week?

As the year draws nearer to a close, the long end of the yield curve has been the trade of choice for market participants looking to put cash to work for a little extra yield. Illustrating added demand for the long end of the yield curve is the recent flattening of the 2s/10s curve. It happened in a hurry...a healthy bid for 10s has corrected an entire month's worth of yield curve steepening. 2s/10s are once again testing the all important 252bps spread level.

While mortgages were performing well enough on their own prior to the rapid decline of benchmark rates, the recent rates rally has served to lead the secondary mortgage market current coupon below 4.00% as "rate sheet influential" MBS prices visit record breaking territory (SEE MBS CLOSE)....pushing mortgage rates down to 4.50% in the process. While profit taking is expected to occur across the MBS coupon stack, supply and demand technicals continue to support valuations as anyone looking to sell MBS has found their offer will be met with almost three times the demand. Again..a function of cash being put to work heading into year end. 

The MBS rally in both price and yield spread has extended into this week. Price progress is obvious...

Spread performance has not been as easily noticeable...unless you have a spreadsheet that tracks MBS yield spreads...

Notice the difference between the MBS Current Coupon (CC) and 10yr TSY/10yr swap gets lower and lower. MBS have greatly outperformed benchmarks over the past two weeks (almost three weeks now).  Also notice what happened today...MBS was unable to keep up with benchmarks. This is the profit taking we have been discussing..."rate sheet influential" MBS ARE TOO RICH. While year end buyers will likely help keep spreads from blowing out (Black Wednesday)...we do expect profit taking to be a theme for the rest of 2009.

The range consistently moderated directionality over the summer, into fall, and continues to do so heading into winter..while trips outside the range have occurred, they have not lasted long. We must continue to base our bias on the price levels accepted by the marketplace. That said, while we are thankful for rapid appreciations in the rates market, we are not comfortable with the speed and style in which they occurred. Play the range until the range plays you (and proves it).

Lock em if you got em