MBS OPEN: Positive Progress Intact But Under Pressure
After taking down $84 billion in TSY debt supply last week, the bond market headed into the three day weekend trading outside the range at yields not seen since mid-December. The positive progress made over the course of the week served to add bullish momentum to our strategy and further skew our outlook toward lower rates in the near term future (week to week). However, although the general tone of a short term correction carries over into this week as the economic calendar is more or less empty and TSY debt supply is muted, prospects for a "relief rally" have yet to extend out past the short term time frame
Adding a twist to the week ahead is the steady influx of influential earnings releases: Citi this AM, Bank of America, Wells Fargo, and Morgan Stanley on Wednesday, Goldman Sachs on Thursday.
While it has become expected that bankers and dealers with cheap costs of funds will profit from the steep shape of the yield curve, the road ahead remains muddled with economic uncertainties, making for mixed forecasts and defensive outlooks. It has still yet to be determined how core business models will perform over the years ahead while consumers repair household balance sheets and re-accumulate wealth. On the surface this would be considered a positive for bankers, unfortunately the unclear outlook also creates a need for banker balance sheets to be prepared for the worst...this implies the market should expect boosted loan loss reserves and continued credit quarantines.
With that in mind...barring huge surprises to the upside, the hesitant tone in the marketplace combined with more intentions to test corrective resistance levels may just be enough to keep positive rate's market progress in tact for the time being....
To start the week....
Both 10s and "Rate sheet influential" MBS coupons have been poking and prodding at resistance levels...these progressive tests have unfortunately FAILED. 10s are now moving back toward the 3.71% to 3.75% level. Last week we told you we were OK with this as long as 3.75% wasn't broken in size (in high trading volume). At the moment 10s are trading -0-10 at 97-07 yielding 3.715%. If 3.75% support holds and rates continue toward lower yield levels, we are targeting 3.62% then 3.57% then 3.52%. I see 3.57% as a "stop and re-evaluate" pivot point, meaning I would expect the market to begin to take profits and re-consider the extent to which rates have been allowed to move into lower levels.
After breaking out of the "old range", last week, FN 4.5s are attempting to head back towards lower territory. 100-20 should offer support for falling prices and higher mortgage rates.
This is partially a function of stocks doing a bit of "correcting" themselves. Equity futures were down all morning, but are making a comeback at the moment. Below is the S&P index, 1142 is resistance. A failure to break this pivot point would be beneficial to the bond market.
REMINDER: While prospects for a "relief rally" did indeed brighten last week and our housing focused BIG PICTURE economic nervousness has yet to be calmed, we still haven't observed a viable reason to believe that rates will sustain progress in the long run. Budget deficits and still ballooning US borrowing needs keep our bias skewed toward higher rates in the month's to come. To be more clear, when we say "short term relief rally" ...we are operating on a week to week basis as we have yet to observe a viable reason to believe that the bond market is capable of sustaining the corrective pace since suffering from a lack of liquidity induced "disdain for duration" in December.
Plain and Simple: we think rates continue to make corrective progress this week, but find it difficult to believe this rally extends into February (barring economic or political tapebombs). Expect some variation of a range trade with 10s maybe testing 3.50% again.