MBS OPEN: Bond Market Weakness Intact After CPI Data

Good Morning. Happy Friday.

A warmer than anticipated read on producer level inflation outweighed a rise in jobless claims and a better than expected Philly Fed print yesterday, this made it possible for traders to extend their bear steepening bias into next week's $118bn TSY coupon offering (+$8bn 30yr TIPS).  That rationale assumes you need some sort of fundamental justification for the reprices for the worse that hit your inbox yesterday. While those factors are obvious in headlines, we know the rates marketplace is short the "rate sheet influential" end of the yield curve and looking to push positions farther into the money.

The FN 4.0 was -0-19 at 97-01 yielding 4.282% and the FN 4.5 went out -0-15 at 100-03 yielding 4.485%. The secondary market current coupon was 4.479%. +67.2/10yr TSY +57.2/10yr swap.

 The biggest news of the day was the Fed's decision to raise the rate they charge banks for an advance on reserves . After the market closed, the Fed announced an increase in the discount rate from 0.50% to 0.75%.  We quickly responded with a reminder that the Fed has been slowly removing itself from money markets and while the timing of such a move was unexpected for many (even though Bernanke said this would happen last week)...it is not that big of a deal! READ MORE. That of course is hard to believe considering the market's knee jerk reaction to the announcement. Global stock futures dipped, the dollar rallied, and 2 year TSY notes got punished as nervous arbitrage traders exited positions in the extremely expensive and overcrowded front side of the yield curve. This helped reverse recent BEAR STEEPENING....the 2s/10s curve spread has been setting new records on a daily basis. The reaction is obvious....but as you can see, it didnt last long. While the Fed's decision to hike the discount rate may have been a kick in the psychological private parts, its not a big deal! In reality it is a reminder that the worst case scenario has been avoided.

Anyway back to the here and now....

Trading volume spiked in yesterday's trading session..10s saw 1.2 million+ cars move in the electronic marketplace. That carried into the overnight session as trading activity EXPLODED on BrokerTec's screens. Of course, while flows were busier than usual, the extreme level of slowness that has occurred over the last few days has skewed short term volume averages. Either way, it was still a reeeeally busy overnight session. Yes I know youre thinking.."BUT YOU SAID THE DISCOUNT RATE HIKE IS NOT A BIG DEAL"....knee jerk people knee jerk.

The Bureau of Labor Statistics released the Consumer Price Index at 830. After PPI printed a bit hotter than most anticipated, some were nervous that those added costs might be passed down to consumers. We have shrugged that thought off repeatedly as consumers are cash strapped and desperately in need of disposable income. That said, with demand still in the john, producers cant afford to raise the cost they charge for their widgets...all they can do is cut costs and hope they stay in the green.

The market was expecting CPI to come in +0.3%...actual was +0.167%. Excluding Food and Energy (COST PUSH INFLATION) prices fell 0.1% in January. Obviously fuel costs are driving inflationary concerns, core CPI on the other hand is well in control. There is still a massive amount of resource slack in the system, this keeps CORE inflation tame. The Fed's decision to raise the discount rate should help the dollar in the long run, which will assist in controlling commodities prices.

Here is a recap of the data. Check out housing related indexes...

I heard a lot of speculation yesterday that a tame CPI print would offset yesterday's warm PPI release and help lower benchmark interest rates in the process. That has not been the case this AM as the spike in trading volumes put a level of position resistance under 10s...this was confirmed overnight. The discount rate decision served to solidify MORTGAGE RATE UNFRIENDLY momentum in an already bearish bond market.

The FN 4.0 is -0-03 at 96-30 yielding 4.291% and the FN 4.5 is -0-04 at 100-02 yielding 4.499%. The secondary market current coupon is 4.493%. The CC yield is +69.4bps/10 yr TSY yields and +59.5/10yr swap rates. Although there was a brief bounce after CPI data, yesterday's price weakness is intact.

Plain and Simple: the bond market already had a fair amount of momentum before PPI, Jobless Claims, Philly Fed, and the Discount Rate hike. Traders will ride this bearish wave as far as technically possibly.

There is a bright spot here....has anyone noticed where mortgage rates are relative to MBS pricing???? The last time the FN 4.5 hit parnertia, the average 30 year mortgage rate was 5.18%. Mortgage rates have not risen nearly as much as benchmarks. Thank you Federal Reserve. Lenders need business! Good observation BC.

While the Fed's gradual exit from money markets is another sign of positive economic progress off of historic lows, it does not change the fact that we are still skeptical of developments in housing. 57.4% of permanent loan mods were made to borrowers who are out of work or underemployed. If those folks can't get work, they wont be able to stay current on their mortgage obligations.  Better hope banks don't dump their foreclosed assets on the market all at once!