MBS OPEN: Rates Rallying But Still Stuck in the Range

The jobs report came and went with much fanfare, although we witnessed a fair amount of post-print price volatility, the bond market ended the week no better and no worse. This left many wondering whether or not a month of "rate sheet influential" benchmark selling was indeed indicative of things to come in Q1 2010 or merely a function of a lack of liquidity and trend trading.

At first glance one might automatically assume, given the rates market's failure to correct following what seemed to be a bond friendly  NFP release, that rates were doomed to hold at higher ground, however we must remind  of the Treasury's intentions to offer $84 billion in coupon supply this week, not to mention the onset of Q4 earnings season which will likely present more balance sheet "better than expected's" (thanks to constant cost cutting and cheap cost of funds...should say P&L better than expected's).

While I am in no way trying to paint a positive picture for the bond market, especially the "rate sheet influential" (long end of the yield curve), I do remind that this is still a trader's market and headlines are not necessarily an indication of underlying economic assumptions. This would imply that a significant supply concession has already been priced into the fixed income sector, making this week a decent candidate for "bargain buying" and sideways trend channel testing.

Plain and Simple: Yes that means we see a decent chance for strong buying at the lows/short covering to help jump start a bit of a rally in the rates market. 

Unfortunately, short term buying opportunities and profit taking positioning are not doing much to change our outlook for higher rates in Q1 2010. (Well, perhaps I should say holding at current levels or moving higher.) With that in mind, while several opportunities may arise to capitalize off of short term rate sheet rebate rallies...our overall bias remains in lock mode with hedge ratios holding at or above 90%.

This again calls attention to a dynamic that has moderated directionality over the course of the year: IT'S STILL A TRADER WORLD AND WE'RE STILL LIVING IN IT

I know I already pointed this out above but I feel like it is important to again recall the disconnect between perceptions of economic reality and the market's ability (or inability) to accurately assess asset valuations. The macroeconomic road ahead remains INCREDIBLY UNCLEAR with assumptions based on assumptions and statistical variations running rampant. That said, try to avoid attempting to rationalize market movements with BIG PICTURE evolutions. We unequivocally believe our bearish slant towards stagnation, anemic economic activity, and a luffing labor market will at best return gradual growth...implying the housing market has a rough road ahead as many of the jobs that were lost during the course of the year have likely been lost forever. (GO BACK TO SCHOOL).

Plain and Simple: While our Q1 bias is for higher rates, beyond that lies a rocky road towards recovery with chances of double dips rising as the marketplace comes to grips with sideways economic activity. With that in mind, one has to speculate on eventual asset discounting as the market comes to grips with the  growing glut of "extended" claims for unemployment insurance. This leaves the door open for a return to safe assets in the yield curve and cheaper consumer borrowing costs (beyond Q1 2010).

Although still confined to the range that contained price progress last week, the bond market is improving to start the week.

The 3.375% coupon bearing 10 yr TSY note is +0-08 at 96-16 yielding 3.802%. A break below 3.80% would lead to a test of 3.78%. If the 3.78% pivot is tested and the market deems valuations cheap enough to march on towards lower levels we'll see a move down to 3.75%. At that point we would be issuing notices of lender reprices for the better...

In the chart below I highlighted the outer limits of the range, with RED being reprice for the worse zone and GREEN being reprice for the better zone. While above I pointed out an opportunity to see a bit of a bargain buyer's rally this week...failures to break through 3.78% and test 3.75% with some conviction will not imply bonds are stuck with a bearish bias as much as the market is not interested in removing anymore of the supply concession that has been priced into the Treasury market. However, a failure to make progress AFTER this week's round of debt supply would be indicative of continued bearish sentiment in the bond market. 

 The FN 4.5 is +0-07 at 100-10 yielding 4.476%. I do not like to create confusion about the extent to which mortgages are tied to the movements of benchmark yields, however given the Fed's involvement in the MBS market and the continual lack of new loan production supply...we are essentially at the mercy of the gyrations of the yield curve (swaps and TSYs).

In the chart below I called attention to the sideways range formed by FN 4.5s. "Rate sheet influential" MBS coupons have failed to spend much time over 100-14...look for lenders to keep rate sheet rebate relatively range bound until the 100-14 pivot point is broken through and confirmed with a volume spike as new position are added.

At this point in the day, if lenders priced right now, reprices for the better would be considered at 100-18. Reprices for the worse near 100-06.

NEXT EVENT: $10BN IN 10YR TIPS AT 1PM

PS...Today is Class A Notification Day. This means the settlement process will begin for January FN and FRE 30 year MBS coupons. At the end of the day MBS prices will seem to drop off 11 or 12 ticks as we roll over to the February MBS coupon. Do not panic when you see this...it is a normal MBS market event. (Saw lots of roll trading last week when prices dipped into lower end of the range).