MBS WEEKLY: Bearish Bond Technicals Battle Mixed Econ Outlook
Well well well, look where we sit. 10s rose from 3.60 to 3.80 in seven sessions. Took a short breather. Then fell from 3.80 to 3.60 in four days. Chop chop chop.
On the week, the 3.625% coupon bearing 10 year Treasury note was +1-09. That's +41/32 from 98-24 all the way up to 100-01. Yields fell 14 basis point from 3.76% to 3.62%.
Looking at a longer timeline....notice the cluster of weekly moving averages and rapidly narrowing trend channel. This pattern is called an ascending triangle or continuation pattern. It illustrates how trader positions are accumulating at higher and higher levels. If this chart was price, it would be very bullish. Meaning we would soon expect a breakout to the upside in the near future. Since the chart below is yield, we have to call it very bearish, at least for those who want lower interest rates. Yields are trying to head back toward more historic norms. THIS IS WHAT THE CONTINUATION LOOKS LIKE
I know what you're thinking: Yeh but the yield curve really flattened this week! Doesn't that imply a big shift in the demand for the long end of the yield curve? The rate sheet influential side..10s.
Good observation! I noticed that too and thought back on how it got to be so steep in the first place. Remember two weeks ago when China was out five straight days for Lunar New Year? (AMONG OTHERS). Well China is one of those "real money" accounts who is known to provide supportive bargain bid when rates are rising. Sometimes their influence snowballs and forces short positions to be covered, which snowballs the snowball already in progress.
Notice the yield curve underwent its record setting bear steepener during that week. The bond market was without a buyer that week. We were especially vulnerable. This corrected when Asia came back to work.
Since we already discussed the technical challenges faced by the 10 yr note, lets look at the other side of the 2s/10s yield curve trade: the 2 year Treasury note. Looking at the chart below you can see that 2s have held to a well-defined range over the course of the last year. Right now yields are pretty close to range resistance. Not much room to move lower.
Plain and Simple: 10 yr charts are set up for a bearish breakout, 2s don't have much room below, and the recent bear steepener reversal is testing a key pivot point. We've come a long way in a short time and its all unfolded while the market hasn't been totally focused on the ball (snow days, holidays, Bernanke testimony, empty econ calendar days).
On the week, the FN 4.0 was +1-07 at 98-08 yielding 4.416% while the FN 4.5 was +28/32 at 101-03 yielding 4.379%. The secondary market current coupon, which is essentially the base yield lenders use to generate par mortgage rates after servicing and guarantee fees, fell from 4.471% to 4.306% this week.
The chart below is long term. Again I am calling attention to an ascending triangle pattern. In the example provided above, using Treasury yields, I said this formation was bearish because we were looking at yields. However, if the chart had been price, the formation would be bullish. Well, the chart below is in price, but I am telling you it is not bullish.
This is where technical studies can confuse. Mortgage-backed securities are a spread product. Their value is based upon a benchmark. They take their directional guidance from this benchmark, in the case of the FN 4.5 general direction is dependent on the movement of the 10yr TSY note and 10 yr swap rate. There are a few reasons this pattern is not bullish for the FN 4.5. First, the FN 4.5 just doesn't have much room to move higher, prices are running into range resistance. Second, the benchmark FN 4.5 takes its guidance from the UST10YR, which is set up for a bearish breakout. If 10s go higher, "rate sheet influential" MBS coupon prices would decline.
On Thursday we learned that the Federal Reserve made $11 billion net MBS purchases. 96% of their funding as been used. This leaves $44 billion to spend over the next five weeks. If that funding is spread out evenly over those five weeks, the Fed will buy $1.76 per day.
No big deal right? Probably not, the Fed has been gradually spending less and less instead of trying to spread it all out evenly. But this does raise an alert eyebrow. Why? Because originator supply is averaging between $1.5 and $2.0 billion per day. We are entering a phase in the MBS purchase program where Federal Reserve $$$ demand might not offset originator loan supply. This means, in the next month, MBS yields will start to widen against Treasury yields.
Here is a shot of my scorecard. Yield spreads are still very rich. The Fed's exit from the MBS market has yet to cheapen valuations.
I think need to come clean on something.. in case its not already obvious. While I have remained mindful of short term opportunities to hop on board the 'float boat', my general bias in 2010 has been to short Treasuries. I have been more inclined to sell rather than hold. I am bearish!
This is from MBS OPEN on Monday: "Looking ahead, with all hands now back on deck, we are on the watch for an opportunity to hop on board a short covering induced, "buying at the lows" fueled rates recovery bounce (later in the week). Of course this is speculative (wishful) thinking and reality reminds us that any correction is not likely to develop into a long term, originator friendly trend.
The charts I've chosen to present to today support that long term outlook. This bring me to the "admitting" that I need to do. I know housing is structurally weak. Me and my family live in this world everyday. I also know there is a mismatch of labor talent and labor demand. Meaning the skill set requirements for open jobs does not match the skill set of most unemployed Americans. The economy is evolving, production lines are more efficient, technology investments are replacing human brawn and brains. Many of the jobs that were lost over the past 24 moths have likely been lost forever. This has me nervous about the extent to which job creation will be effective in restoring aggregate demand...and the health of housing. This has me nervous about another round of panic that forces a flight to safety reallocation into bonds.
If you are one of those people preaching about a 'double-dip', the labor market/housing market relationship is your ticket.
Don't get it twisted though, you are up against a worthy opponent. Globally, governments and central banks are doing everything in their collective power to avoid another economic downturn. If the 'official powers that be' are truly serious about their intentions to restore financial normalcy, their attention will remain laser beam focused on creating jobs and redistributing wealth around the economy so mortgage payments can be made and prospective homeowners can rebuild credit. This is my biggest concern...its going to be a long recovery battle at best.
So I told you I would keep you updated on my long term outlook. Here it is. I am generally bearish on bonds, as the charts above illustrate. I am however willing to admit there is still potential for a double-dip, especially if jobs and housing are not made a top-priority by the administration.
Do you think our leadership is taking the best approach to restore jobs and housing demand?
The "worst-case scenario has been avoided" camp believes in our leadership. They view the glass as half full. "Double-dippers" either think nothing could have been done to stop the deflationary downward spiral that is in progress or they are skeptical of the Federal Reserve and Obama Administration's policy response efforts and credibility. Did I miss one? Which camp are you in???
The econ calendar contains much less data next week vs. this past week. Personal Income, ISM, Construction Spending on Monday. Non-manufacturing ISM and the Beige Book on Wednesday. Thursday is the busiest day of the week with Jobless Claims, Productivity, Factory Orders, Pending Home Sales, Treasury announces the terms of 3s/10s/30s,and we get prepay factors (UIC delinquency buyout relief too?) Then on Friday , the THE EMPLOYMENT SITUATION REPORT (snow day asterisk already firmly on the print).
LOCK OR FLOAT?