MBS AFTERNOON: Two Sides of the Slow Trade

Well...hate hate hate on the long end of the yield curve today!

The 0.75% semi-coupon bearing 2yr TSY note is trading -0-04 at 99-24 yielding 0.872%. The 3.375% semi-annual coupon paying 10yr TSY note is -1-03 at 97-15 yielding 3.682. The yield spread between the 2yr and 10yr note is now 281 basis points.

I posted a 2s/10s daily chart in MBS LUNCH. Here is a closer look at the bear steepener...aka the "disdain for duration":

When options get more expensive it means trader's are buying more protection against a possible "event"...like the market continuing to sell off. Well...volatility can be very bad thing for MBS prices. An increase in expected interest rate volatility can distort MBS valuations. Remember, MBS yields are based off of prepayment assumptions. Prepayment assumptions are dependent on the shape of the yield curve. Because "rate sheet influential" TSY coupons are selling off and the yield curve is moving steeper at a rapid pace(longer maturity rates selling off more than short maturity)...trader's are buying options to protect their cash flows from further losses...or to profit from further losses.

This implies traders see a wider range of possibilities in benchmark rate expectations...which in turn creates a wider range of possible mortgage prepayment assumptions because quantitative models must account for more scenarios. If it hard to put a number on the most important MBS valuation metric...wouldnt you just wait for volatility to fall before buying MBS?

3m/10yr bp volatilities, which can be traded, are about 9bps higher today. That is a pretty significant rise in implied interest rate volatility. And another example of a disdain for duration.

On the other hand I also saw one large account selling 10yr implied vols, which is the counter trade against the above discussed buying of implied volatility (remember: rising volatility is BAD for mortgage rates). Perhaps this is just a function of a short term LACK OF LIQUIDITY in the marketplace and "real money" is just letting prices get cheaper and yields get higher before BUYING ON THE DIPS.  Volume was terribly brutal today...so its not out of the question.

Also something to consider...

Tomorrow we get GDP data, a report on consumer spending, Existing Home Sales, and the FHFA home price index. That is a busy day of data. Perhaps today's trade was bearish pre-data positioning? Bond bearish, not economy bearish that is...

Many economic outlooks are turning more optimistic as year over year performance metrics will be showing signs of improvement. I again remind: These signs of improvement are really just stabilization from RECORD LOW levels though. The gains are relative, in the big picture, the economy is just putting along, right above anemic activity levels. It only looks like improvement because at this time last year stocks were in freefall and NFP prints were skyrocketing. Not exactly a "cheerful " time for market participants.

Know what I'm saying?

If this is the case and data is not all that it was hyped up to be...corrective/bargain buying rally led by shorter covering real money buying? Just a thought....

Besides a more last minute REPRICES FOR THE WORSE...nothing new to report in the mortgage market. Still at the lows of the day....

Either way the door is wide open for CHOPPY/whippy price action. Just remember the market is protecting itself (taking advantage of) from further rate weakness.