"Rate Sheet Influential" MBS Prepayment Speeds Spike in March

By: Matthew Graham •
  • FN 4.5's up 7 ticks to 99-23
  • 10yr yield down about a bp to 3.947
  • Stocks weaker this AM, underneath the important technical level from yesterday.
  • Focused on Fed-Speak and Auction this afternoon.
  • Could be a big day, knowing may be half the battle, but enjoying the show is all the fun.

It's very uncommon for MBS to be gaining more in price than treasuries on a day where both are positive.  It's also uncommon for the lower coupon MBS (4.0 and 4.5) to have gained as much or more than the rest of the stack when the treasuries are showing a preference for shorter duration paper.  This is because the lower the coupon in MBS, the longer it's duration tends to be, so if long duration treasuries are underperforming short duration treasuries, MBS tend to match that changing shape of the yield curve ("duration-matching").  But not the case this AM...

Several potential reasons...  Most important reason: it's 10yr auction day.  The market's MO has been to build in a concession to 10yr prices leading up to 10yr auctions.  Just because 10yr prices are slightly positive on the day DOES NOT mean the concession isn't there.  Remember that the VALUES of all this "stuff" are measured chiefly in RELATIVE terms.  So if the short end of the yield curve is 2-3 bps lower and 10's are only a bp lower, they are in fact, CONCEDING VALUE.  Hence: "building in a concession" ahead of the auction. 

Additionally, MBS had "room in their trend" to move up, whereas treasury yields faced a brick-floor-like resistance at 3.95.  The red lines on the chart below should help illustrate.

In addition, the monthly report on prepayment speeds in MBS was out last night and this could explain, in part, why MBS lower coupons (longer duration) are leading the charge, whereas shorter durations lead the treasury charge.  The reality of FN/FR delinquency buyouts is becoming evident and if you're an investor recently flush with cash allocated in MBS, I'm thinkin' the 4's and 4.5's look a bit more predictable than higher coupons.  "Rates low for extended period" means that 6.0 and 6.5 MBS still run the risk of paying off too fast for current price levels in the future.

Auction coming up at 1pm!

BERNANKE AT 1:30PM! 

Hoenig at 2:00pm, but after bernanke, will we care?

(update: Dudley spoke at 12:15pm, and if there's any reaction in bonds so far, it's slightly positive, but not really noticeable)

Things are either going to get really great, really quick for MBS, or insanely volatile.  EXPECT THE VOLATILITY!  THESE ARE BIG TIMES IN THE BOND MARKET.  And today is the biggest day of this week of big times.  With a 10yr auction followed only 30 minutes later by Bernanke, with stocks at 18 month highs, bonds at 18 month lows, the Fed out of MBS, 10yr considering test of 4.0, Geithner making nice with China, and whatever else, you're going to want to expect the volatility.  And sadly, it happens often on auction days where we see enough of a movement to justify reprices for the worse, only for things to improve by the end of the day.

So let's hope we don't have to deal with that due to a clearly bullish auction!  See you soon!