MBS MORNING: Range Breakdown Confirmed by Heavy Selling

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The rates market continues to trade lower....not in rate though, in price. That means RATES ARE HIGHER!

10s have made a move to the 3.62% pivot point, if you recall both 3.57% and 3.62% were out targets following the Labor report bond market selloff. That said, today's heavy volume selloff does indeed serve as confirmation of a RANGE BREAKDOWN. This implies 3.57% handle is now resistance, which the market already tested and FAILED!

Disdain for the long end of the yield curve (longer duration debt) has not been so friendly to "rate sheet influential" MBS dollar prices either.

Both the FN 4.0 and FN 4.5 are testing intraday lows.YAY! The FN 4.0 is -0-14 at 97-29 yielding 4.201% and the FN 4.5 is -0-12 at 100-23 yielding 4.432%. The secondary market current coupon is 4.386%...10bps higher from yesterday's "going out" marks.

This is a function of the previously discussed "disdain for duration"...which is illustrated by the steeper yield curve.

When benchmark interest rates rise the duration ( life) of "out of the money" (at par or below par) MBS coupons lengthen. The farther out of the money an MBS coupon is the more it's duration will extend when benchmark rates rise (because those borrowers have no reason to refinance).

Plain and Simple: MBS buyers dont want to be stuck in a fixed income investment that isn't keeping up with its benchmark...if interest rates move higher this implies they could be reinvesting their money in a higher yielding debt instrument...they could be making MORE CASH FLOWS!!!!

Check out how the 2s/10s curve continues to STEEPEN. When the spread between the 2yr note yield and 10yr note yield reaches 275bps we will have to call Guinness because it'll be a new record.

Edgar made this statement last night...

"Previous post asked what are you waiting for????? I am waiting for .50 YSP to return once retailers let the cat out of the bag that things are not as rosy at the over 1% increase YOY retail sales number for November indicates. Or how about weekly unemployment going back above 500k this week? Maybe a state or two announces they are going to default - watch out New York. Dangerous as there is a lot of pressure on rates to move up....but I'm feeling risky these days. I still remember the current CEO of Lehman saying: we are entering in the pretend phase (summer of 2009), everyone is pretending we're okay. Throw 12 trillion at the problem, move some debt around and we're fine. Didn't Volcker or Summers just recently say-take away the feel good money, and we have no economy?"

His comments are hard to look passed. Here was my response:

"yeh...a lot of opinions are calling for some variation of a double dip. if not, at least a long period of anemic growth/stale recovery. I happen to be one of those people. makes you think twice about 10s moving back up to test 4.00% right? I still feel like there are enough reasons to consider the short side of the trade though. in considering this sentiment shift in terms of GUTFLOP. both strategies are assumptions based on assumptions, since I am more apt to believe in HIGHER RATES than lower... I would consider locking more than you float in early 2010. I say this to protect your pipeline from the increased likelihood that the market reprices for the worse in early 2010 (aka trending action out of the 3.26- 3.50 range into the 3.56 to 3.81 range.)"

Jann interviewed me on the MBA Forecast story yesterday.  She asked me what my outlook was for 2010. Here is my response:

I have yet to provide my mortgage rate outlook beyond Q1 2010 because of a large amount of unknown variables currently clouding the marketplace. These include:

  • The January 1 implementation of FAS 166/167
  • The possible extension of the Fed's MBS purchase program
  • The termination of several other Fed liquidity facilities including reciprocal currency swaps, the TSLF, ABCP, TAF, the PDCF, and TALF.
  • The sale of the Fed's assets. Although the Fed has discussed the reverse repo program, the market has yet to learn of the timing of the Fed's strategy to sell the assets accumulated during the Quantitative Easing process (MBS and Treasuries specifically).
  • The market's perception of inflation and its relation to the budget deficit are working against each other. 
  • HOUSING

I have however stated that I see a strong possibility that the 2s/10s yield curve could test all time steepness spreads as the 10yr approaches 4.00%, which would likely push par 30 year mortgage rates up to 5.50% by the end of Q1 2010. This assumes the Fed will not find reason to extend the MBS purchase program and that the market would not price in a "double dip" (if the Fed extends the program it is because the economy needs them to extend it. If the Fed does decide to extend the MBS purchase program, it would imply the economy is failing to grow or taking a turn for the worse. Looking further out, "double dip" risks remain high due to the overhang of unemployment, continued resource utilization slack, and stagnate housing demand.

The reason I bring this up is to hear some feedback. I just told you that I saw a "strong possibility" that mortgage rates could move up to 5.50%. I feel like that is a profound statement....yet not much of a response. Do you think I am on crack? If so TELL ME! Haha...

Mortgage servicers were selling "rate sheet influential" MBS coupons this morning. Servicers are one of those "real money" accounts...they must manage the life of their liabilities against the life of their assets. This is yet another sign of a sentiment shift in the rates market.

I am coping with the idea of higher mortgage rates by listening to loud, angry rap.