1/23/08 - BONDS CONTINUE TO IMPROVE

By: Matthew Graham

Mortgage Backed Securities closed near at or near the highs of the session yesterday.  They held very steady with the 5.0% coupon above 100-15/32nds for the whole afternoon despite rapid fluctuations in stocks.

Lenders did not price that strength into their reprices yesterday, and so we advised to keep floating.  You'll be glad you did as not only did bonds hold the line, but have actually made significant progress thanks to another day of the "indigestion" that the markets are experiencing after eating Bernanke's special breakfast yesterday.

It's always prudent to consider the possibility of a sharp rebound when there is a drastic market move in one direction.  There are two ways to look at it.

1. The improvement in bond prices is trend that will continue to improve

2. The improvement in bond prices has come too far too fast and is susceptible to a rebound

Your personal take on the market situation will be the key factor in determining which perspective to apply to the current market.  There are sometimes shades of gray, and even experts who take strong stands can be dead wrong.

Personally, the fact that bonds held the line yesterday (a very flat line) despite flailing stocks, indicates the cliche "flight to quality" buying (market in turmoil causes folks to buy more guaranteed securities).  So although there's a risk of a rebound today as the extremely high bond prices might entice some traders to sell, I think it is well-mitigated by the market nausea. 

That said, I always leave it up to you to watch the markets.  The best indicators we have of market sentiment today are stocks.  It's almost impossible to say what will happen to bonds even if stocks do rally.  Yesterday tells us that bonds, especially MBS's, are RESISTANT to sell-pressure when the market swings back toward positive.  Bonds never decreased yesterday despite the Dow regaining losses.  As such, I think stocks would need to make a pretty convincing run back towards even today to affect market sentiment.

So be vigilant.  Keep a watchful eye on stocks for signs of a significant rally.  It has actually rallied as this is being typed, but bonds remain unconvinced.  The Dow would have to turn positive for the day to force the hand of MBS's.

Keep floating unless it does turn positive.  Then check back here for an alert, or lock if you're cautious.  Remember!  If the dow goes positive before rate sheets, that will already be priced in.