MBS MORNING: Rates Rally Extends But Progress Stalls Before Auction

Good Morning All. Today is the last full trading session of 2009.

In relatively high volume, the rates market was able to hold yesterday's gains in overseas trading last night.  As MG pointed out in MBS CLOSE last night, the move off of recent price lows/yield highs was supported with modest SEASONAL volume. I call attention to 'seasonal' because although volume was above average, it was only strong relative to other post-Christmas pre-new year trading session. 

At the moment the 3.375% coupon bearing semi-annual 10yr TSY note is trading flat,  +0-01 at 96-17 yielding 3.799%.  Notice what was once RESISTANCE is now SUPPORT.  Next target in 10s is 3.76 then 3.72...if momentum really picks up we will see a test of 3.68 then 3.62. If yields move higher, support is found at 3.88%.

In the mortgage market, yesterday's late afternoon rally has extended over into today' session. "Rate sheet influential" MBS prices are have ventured back into premium territory (over 100-00) and MBS yields are outperforming their benchmark's (yield spreads are tighter)....this is a function of real money buying convexity as the yield curve flattens.

RATE SHEETS ARE IMPROVED THIS MORNING. 4.875 is paying.

The FN 4.0 is +0-06 at 96-28 yielding 4.297% and the FN 4.5 is +0-06 at 100-00 yielding 4.509%. The secondary market current coupon is 4.507%.  From the chart below, you can see that we've been battling PARNERTIA over the past few days.

When zooming out, the gravity exerted by the PARNERTIA pivot point (target) is more obvious...it seemed like we were in free fall until we crossed over 100-00.

Chicago PMI for December came in much better than expected at 60.0. This was  the highest read since Jan. 2006 and the fourth consecutive month of manufacturing improvements in the Chicagoland area. All components of the index were better except Supplier Deliveries.

The most influential observation: the EMPLOYMENT index improved into expansionary territory (over 50 = sector expanding) for the first time since November 2007.

Although seasonal support was responsible for part of the improvements in this data...overall it will add OPTIMISM to economic outlooks. Put another mark in the RECOVERY PERCEPTION column.

MORE ON CHICAGO PMI AND INFLATION ON MORTGAGE RATE WATCH

Although I am still unwilling to make any speculative observations based on this price action as my position continues to be on hold in "WAIT AND SEE"  mode heading into the New Year....if I were to look deeper into this bounce, I might say the bond market has been super oversold and last minute real money window dressing buyers are grabbing some yield before official year end (grabbing some yield as in locking in yield spreads aka bargain buying). Based on the month long "disdain for duration" exhibited by the bond market, meaning rates in the long end of the yield curve (rate sheet influential) have risen more than rates in the short end of the yield curve, rates traders were telling us that they expected rates to rise in 2010. As we have discussed, this put us in a difficult spot.

In our outlook for early Q1 2010 (and Q1 2010 in general) we put fairly even odds on two outcomes: a correction back into "THE RANGE" or a brief rally followed by another rates sell off.

For almost the entire month, the bond market has reflected a "the worst is behind us" economic perception. Long-maturity term Treasury yields have moved considerably higher in a very short time frame all while stocks have held steady near fresh 2009 index highs. However, the near term outlook based on these implications has not be confirmed by any volume strength in the marketplace as price action has been distorted by light (thin) trading conditions...there seemed to be no level of support under the rates market, yields just kept rising and rate sheets just kept getting worse.

With that in mind...the question we are looking to address when the new year begins: HAVE HIGHER RATES BEEN A FUNCTION OF SEASONAL INFLUENCES or HAS THE BIG PICTURE ECONOMIC OUTLOOK OPTIMISTICALLY EVOLVED?

This is why I am in "WAIT AND SEE" mode until the new year. I would rather be behind in a rally then upside down in a sell off.

NEXT EVENT: The Treasury will auction $32 billion 7s. Results announced at 1pm. Indirect bidders (foreigners) have showed interest in this maturity. Given the fact that we've seen a decent corrective rally over the past 24 hours...it should be made clear that profit taking is a likely into further strength.