Slight Improvement Over Yesterday with Limited Data

The Only Scheduled Economic Releases for Today are Store Sales which have shown a week over week decline of .2% bringing the year over year change down to 2.3%, more signs of a weakening American Consumer.  In a related release, the Redbook index showed a 1.4% advance compared to the same week last year.  This data is normally not a big impact on MBS pricing and today is no exception. 

Of more importance today are the financial headlines and the concomitant reaction in the stock market.

The biggest news of the day is the 3rd straight quarterly loss posted by Fannie Mae.  They announced they will cut their dividend to pad the balance sheet.  Some are speculating that they may be the next mega-firm to need a bailout from another financial or from the FED.  This is the main factor driving the equity markets lower today, with the Dow currently down 80.77.  Normally, the action today and yesterday would have a bigger positive impact on MBS pricing, but there are two factors at play keeping prices relatively steady.  First is the fact that although stocks are being dragged lower by earnings, the poor showing is coming from a key player in the MBS market (Fannie).  It's a mixed blessing because to some extent, it feeds the fire of perceived instability for the MBS market relative to other fixed income securities.  As such, we've seen the spread between treasuries and MBS Gap out a bit this morning and yesterday.

Additionally, there are flow issues to contend with.  This is the sort of info that's not readily available, even to the other MBS commentary websites, and when the curve seems to "not make sense," flow considerations are usually the underlying cause.  In this case, we have a healthy dose of servicers, who account for a substantial portion of the "buy" side of MBS, repositioning.  In other words, they are selling the coupons they think will pay off more quickly and moving to coupons that are likely to have less prepayment in the coming weeks and months.  This selling and buying more or less offset each other, but there can be a lag time in that they do not simply sell their 5.5's and immediately stop at the 5.0 store on the way home.  So this creates some artificial price deflation in the MBS market.  Combine this with the fact that Japan, one of the countries that actively participates in MBS buying, is in the midst of Golden Week  (one of Japan's three busiest holiday seasons), and we have yet another factor that is trimming some demand from the "buy" side of MBS.

As we always discuss, a lack of buying demand forces sellers to lower prices to entice what buyers they can.  And these lower prices equate directly with higher rates from your wholesalers.

So in a vacuum (i.e., no Japan Holiday, and equities driven down by something other than Fannie Mae), we would have much better price improvements today.  As it sits, we are at 100-18 on the 5.5% coupon, not a bad price level to be at in the grand scheme of the last few months, especially considering the Dow up around 12,850 or higher.  The last time the dow was at those levels, when we were headed down into the bowels of the downturn, MBS pricing was significantly worse.  The closing of that gap is evidence that investors "spookiness" regarding MBS versus guaranteed money like treasuries is steadily decreasing.  This is great news for us as a future drop in treasury yields and the DJIA will be conducive to much lower rates than we saw the last time the 10 year was under 3.5 and the Dow around the low 12's.

In other news, UBS announced a massive loss of 10.9 billion recently and announced job cuts and their intention to exit the municipal bond market (a 2nd cousin to MBS).  This is another one of those news items that, if UBS were not a participant in the bond market, would be much better for MBS pricing.  

Finally, oil prices continue to be more effective than ipecac or my mom's version of moo goo gai pan, at creating unbearable nausea.  Historically, oil and MBS are not closely linked, but now we are seeing more signs of cause and effect, although there are offsetting aspects.  In one way, oil being over 120 a barrel is bad for MBS in the sense that it adds to inflation of goods and services as higher fuel costs must inevitably be passed on to consumers.  In another sense, it can help MBS by hurting stocks.  Higher oil prices mean consumers have less money to spend on those goods and services so consumer readings decline, stocks decline, and the door for fixed income investments is flung open.  Very tough to say how much side A or side B of this double edged sword cuts into MBS, but the fact that this market is very emotion driven currently, and that oil is one of the most emotionally charged movies of the year is something to consider as we attempt to determine which traders will be crying sad tears and which will be crying happy.

All things considered, the fact that MBS is positive on the day is good news and I hesitate to say a sign of strength and resiliency.

We will certainly be floating into the afternoon with the still-overbought equities market appearing poised for a drop, MBS spreads to treasuries holding on to their tightest range in recent memory, and treasuries also appearing "run-up" a bit and poised for a potential drop in yield.

Still, the stock market and headline risk will be the market movers for the rest of the day.  MBS are tracking nicely with treasuries this morning, and I'd wager as well that for every 20 points the DJI improves, we'll lose a tick on the bond market.  So keep your eye out for a stock rally or an increasing yield on treasuries as signs of a potential MBS price worsening.  As always, we will update you if we see any drastic swings for the worse.  But until then, it's another day in the pool with the water wings on.