MBS CLOSE: Illustrating Deceptive Effects Of Low Volume

We've reference "VWAP" before, though it's not a metric that makes it into every post.  VWAP stands for "Volume-Weighted-Average-Price."  We find it to be an incredibly useful, simple, and logical tool in telling another story about what is happening in the markets beyond the simple price charts.

In short, it WEIGHTS a given price with the VOLUME traded at that price.  As such, it tends to show a much more stable picture of most trading days considering that volume tends to congregate most heavily at or near one price and taper off as it moves further and further away from that price.  Here's a visual on this concept of "distribution"

As you can see the volume congregates most densely around 116.28 and generally tapers off from there.  This isn't always the case, but it's often the case when there is a lack of data or other events causing divisive positions.  In other words, this could look like TWO prominent peaks on the high and low section of the chart, but the distribution shown above is more common.

So with the roller coaster of prices over the past several days, and not much to talk about compared to last week, one of the most significant characteristics of recent trading is the lower and lower volume as the holidays approach.  So the VWAP chart below gives a sense of just how much this exceedingly low volume can distort the prices.  The lighter and more stable line is the average price at which a majority of the volume has traded, while the black line is what we've actually been forced to confront as originators.

As you can see, the "real" trading range is a bit of a different picture than that painted by mere price movements.  Given though, that the 10yr contract is not an MBS, how then do MBS look compared to the futures market?

The scaling distorts the picture somewhat, but today especially, the directionality of MBS closely matches futures.  And guess what!?  The low volume is a close match as well!  So although there's no repository from which to pull a reliable and complete enough picture of MBS volume to provide you with a side by side comparison of VWAP, but given that we CAN know that overall volume in MBS was similarly low, and that today's price curves are quite similar, it's a safe assumption that a similar distortion is presented in actual MBS prices.

All of this IS NOT to argue that "rates are supposed to be better according to the volume," but simply to say "volume doesn't necessarily support the fact that rates are this high!"  BIG DIFFERENCE!  If you need more clarification on why, PLEASE let us know in the comments.  Basically, we're not dealing so much with the overwhelming presence of something positive, but rather, the seemingly overwhelming presence of something negative turns out to be not-so-overwhelming.

Taking all of this in conjunction with the slightly bearish economic tilt on the week's data and the abundance of short positions in the bond market, is enough to at least keep the short term outlook balanced.  Long term, AQ and I arrived independently at the "2010, not as good as 2009 for rates" conclusions, but with a yield curve over 280bps, and the steepest drops in bond prices since May (not to mention the highest treasury yields since August), I think you'd have to count on a lot of bond-bearish data  and events in order to support this recent back-up in yields. 

That's not to say those events are not possible, because they certainly are, but all things being equal, there's evidence to suggest a correction in the near term is as likely as sideways movement and potentially more likely than continued losses.  Hopefully we're seeing MBS put in a show of support here around PAR and the 10yr do the same with 3.75.  But given the distorting effects just shown from low volume, even if that's NOT what we're seeing, we may not know until traders start filing back after the holidays.