MBS MORNING: Real Money Accounts Doing Some Buying
After 830 data, thanks to a round of real money buying, the bond market improved off overnight lows and yields tested recent resistance levels.
The 10yr yield moved down to 3.57%, but failed to break through this resistance level. 10s are currently +0-06 at 98-12 yielding 3.571....
Remember, in MBS MORNING yesterday, (you know the post where I said mortgage rates might rise to 5.50% if the yield curve continues to steepen and the Fed slows their MBS purchases)...I pointed out the following:
"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% level is now resistance, which the market already tested and FAILED!"
This goes to show you that "positional resistance" can be a significant pivot point for market participants. Ahead of the FOMC statement..."real money accounts" continue to nibble at 3.57%. Volume remains VERY THIN this morning, so a break through 3.57% doesn't necessarily imply a BULLISH bias has set in over the marketplace.
In the MBS market, the FN 4.5 is poking and prodding at 101-00, but has yet to breakout.
The FN 4.0 is +0-02 at 98-02 yielding 4.186% and the FN 4.5 is +0-03 at 100-30 yielding 4.418. The secondary market current coupon is 4.364%. The current coupon yield is now 76 basis points higher than the 10yr TSY yield and 65bps higher than the 10yr swap rate.
I have been referring to "Real Money Buyers" on a consistent basis lately.
Heading into year end these "real money accounts" have been the most active participants in the Treasury and MBS marketplace. This is out of necessity (and window dressing too).
Real Money account's primary purpose of investing is to offset a stream of outgoing cash flows with a stream of incoming cash flows. This is accomplished using the structure of a fixed income investment vehicle (MBS or TSYs). The best way is that their activities have defined investment purposes, rather than speculative activities (which have a minimum time horizon of a minute).
These accounts are matching future obligation with a stream of future cash flows. As the expected life of their liabilities adjusts, with the yield curve, real money accounts must manage the expected life of their incoming cash flows.
Plain and Simple: real money accounts put their assets to work to offset the cost of their liabilities
Examples of real money accounts include Pension funds, Banks (more spread players than duration matching), and Insurance Companies who have either written long term loans or have outstanding annuity obligations that must be paid out at a predetermined future date or schedule.
Using a 30yr MBS (with an effective 10yr average life), a 10yr CMBS AAA bond, or a 5yr or 10yr CMO traunche, which were constructed specifically for real money accounts, is usually the typical way to address such a future obligation while earning extra bps in return.
Real money accounts do as much window dressing as hedge funds—however their efforts are more concentrated in AAA fixed income assets like TSYs. This is because they’re looking to demonstrate their ability to implement conservative strategies, rather than their aggressiveness, while still earning large returns.
Short term FOMC trade positioning: a dovish statement and less optimistic economic outlook would be very beneficial for the currently oversold bond market. The recent round of "better than expected" econ data combined with budget deficit induced inflationary fears and a general lack of liquidity as we head into year end have all combined to push rates in the long end higher and the yield curve steeper...towards record high spread levels.
Perhaps, in the short term, we can expect a modest correction in rates if the Fed plays to the steeper yield curve is today's policy statement. This does not change my outlook for Q1 2009, unless something changes in the BIG PICTURE outlook, I see many more reasons to believe rates are headed higher towards the outer limits of the 2010 range. (10s have potential to re-test 4.00%)