Lots of Headlines, Little Change
We ended the day strong yesterday despite a late afternoon hump as the Dow decided to sell-off a bit and more Dealers jumped on the MBS bandwagon. The move higher was actually fairly pronounced in light of the data from the rest of the day. As such, we've given back a bit today, but it shouldn't hurt much. But the level to which your rates are affected this morning will have much to do with the lender on your particular file. Several of them bet on the come late in the day and may be giving something back this morning. Others didn't quite make it to the party yesterday afternoon so they may actually be improving slightly considering the 5.5% coupon is still trading within 4 ticks of yesterdays first set of highs (the second set came at the end of the session).
Whatever the case with pricing this morning, if you like it or love it or want some more of it, just be aware it may not be around after Bernanke starts talking. It could get better, it could get worse, it could stay the same. If he comes out with more strong language regarding the FED's commitment to invest in the MBS market, this will certainly not hurt. If on the other hand, the rate cut is 1.0 or higher, this could re-introduce inflation concerns and cause some harm to bonds. The one interesting result in that scenario could come if inflation is a concern, but "warm fuzzy" comments are delivered on MBS. In this case, due to the still extreme spreads between treasuries and MBS, we could see traders moving money into MBS despite inflation concerns. Speaking of inflation concerns, let's get to the news:
1. The overall PPI (Producer Price Index) came in at the expected .3%. The core data however, excluding food and energy prices, rose .5%. Estimates were only for .2%. Although the CPI is the more important of the Price Index reports, this is still not the best news for inflation and probably a limiting factor in this mornings MBS market.
2. In the housing starts report, new builds were down by .6%. This was actually a bit higher than the consensus. Permits however fell over 7% to 0.978 million.
3. Retail Stores posted a .4% week over week change and a 1.6% year over year change, tepid numbers, and hardly getting any attention this morning. The Redbook also came in at 1.1%, less consequential still.
4. Lehman and Goldman earnings both exceed forecasts. This will be great for stocks this morning, thus pulling a nominal amount of money out of the bond market. But remember that Lehman is the largest underwriter of MBS, so in a roundabout way, this is also a positive statement about the quality of MBS. So keep an eye on those spreads from the MBS to the 10 year treasury. This data suggests the gap should close a bit today.
5. Fannie and Freddie are working on a deal that would allow them to issue more preferred stock, dodge one of their currently restrictive imposed fees, and basically get deeper in the pool (pun intended). Any news that promotes liquidity and stability is good new for MBS, and will tighten our spread to the 10 year UST.
6. Oh yeah, and who could forget the FOMC announcement later today. You know, that one that comes two days after the almost-unheard-of weekend rate cut; the one that has created more varying predictions than Miss Cleo; let's talk about that for a moment.
The markets are scrambling to take up their positions before the FOMC announcement. As I'm writing, stocks opened sharply higher, no doubt owing to some of the above news combined with anticipation of a 1.0% rate cut. This is causing a bit of a sell-off in bonds. We've reached the levels of noon yesterday now (5.5% approx 101-02). This slide will probably continue, so lock early if you're scared. Ideally, we would have had one of those "calm before the storm" FOMC announcements where there isn't a lot of market data to digest the day of. But no, we have a very full day (not to mention previous week) of news which has stirred up all the differing opinions of what the FOMC will do. I've heard everything from .5% to 1.25% in the past 12 hours. I've heard some people tell me that Fed Funds Futures support a whole point cut, while others have used the same data as evidence for a whole point cut. I would have hoped that traders would have stayed on the sidelines a bit more this morning, but they are not. There's a sense that maybe they weren't in the right place yesterday afternoon, so they are hurrying quick to get there.
Blah, blah, blah, blah. I'll get to the point! What does it mean for MBS?! What are going to happen to my rates today?! Unfortunately, that answer has changed in the 20 minutes I've been typing. MBS have slid appreciably now, toeing the line at 101-01. Most lenders haven't released rates, as they'll want to wait for this slump to stabilize. When all is said and done, the aggressive lenders from yesterday will have had to take a good portion back, and the "few and far between" price change lenders will be little changed from yesterday depending on when they released rates.
The bigger question is what to do in the face of an unpredictable FOMC announcement? Good question. You already have the facts necessary to make your own decision. Here are a couple possible outcomes:
1. Fed cuts .75 (which would be less than most of the market expects). This will have a slightly positive impact on MBS. It wouldn't quite be viewed as a sober and conservative move by the FED, maybe just a little tipsy.
2. 1.0 Cut. This would be in line with majority expectation. This is starting to get a bit inebriated in my opinion. Continuing to cast aside inflation concerns for what amounts to a "PR" rate cut will have a negative impact on MBS IF the stock market likes it. This would probably be the case and would add to the momentum from this morning. Though likely, a 1.0 cut is too high for MBS, although they can weather the storm if the market's reaction is underwhelming.
3. 1.25 (I've heard this rumor floating around, and they've surprised us before). This would be plain drunk, and a clear indication that the FED doesn't care about inflation as much as desperate stimulation. Will the MBS market agree? Probably not to the same extent. This could be bad for ALL markets as the big financials will have to worry about MBS liquidity if investors are scared off by inflation. Talk about a vicious cycle!
4. .5 cut. After quaffing this brew, the Fed would still be ready to meet your parents. Although it won't happen, .5 would send the message that we are committed to fighting inflation as a means to economic recovery as opposed to stimulated a fundamentally un-stimulative market. But a guy can dream. Rates would dance in the sun if this .02% chance comes to pass.
So what should you do with your loans? Boy I wish I knew! As we speak, MBS has recouped a bit, back up at 101-04. Lenders will slow-play you this morning (sorry for all the poker analogies, but that's the game you're in if you have loans to lock) by not pricing their solid gold into sheets until later. It looks like the DOW has found it's happy vantage point for the announcement siting at around 12190. MBS's comparable vantage point would be around 101-06. The trick is to predict what will happen in the 5 minutes following the rate cut. That may be about all the time you have to react. Of course, have your lock sheets on the fax, ready to hit the send key.
With spreads to the 10 year UST tightening up quite a bit in the past few days, any good news for treasuries in general will be good news for MBS. Usually of more importance than the rate cut, is the carefully crafted verbiage released by Uncle Ben along with the "news." We're hoping for him to say something like "continued commitment to providing liquidity for the financial markets" and "take necessary steps to participate to whatever degree necessary to make MBS a safe investment." Ha ha! Well, that second one was a dream, but you get the picture. We want him to say: economy = bad, our participation in buying MBS will continue. Those are two of the most likely beneficial statements we could receive. If we get a .75 cut or less, combined with the above verbiage, I'd keep floating. Anything else, unfortunately, is going to require a wait and see.
The reason for this is that remember, there have been times in the recent past where the FED has cut as much or more than expected. Everyone would think this would stimulate stocks and bonds would suffer. But on those occasions, it has been the market's reaction for than the cut itself. If the market was not impressed by the cut, then bonds actually rose despite the more aggressive rate cut. This is the best thing we could hope for on the heels of a 1.0 or 1.25 cut. Regardless, I think we'll hold the line at 101-00 today. Check back here immediately after FOMC for my take on the language and incessant up to the minute updates following shortly thereafter.