Off Topic Commentary On The Bigger Picture...

Occasionally, we'd simply like to share something to contribute to the broader knowledge base of our readership.  Recently, I've received some inquiries regarding the relationships between Treasury Bonds and MBS.  As we've discussed both on this blog and on articles on the main www.mortgagenewsdaily.com site, to follow treasury prices to get an indication of mortgage rates is folly.  But Why?

The "why" is one of the reasons that I make it a point to let you know specifically when a given day finds MBS "tracking well" with treasuries.  Some of you may be wondering why I would go to the extra trouble to point this out when the common assumption is that MBS always track well with treasuries.  In fact, they do not.  They are always related, but only inasmuch as treasuries serve as a risk-free benchmark against which other fixed income investments are judged.

So MBS are a unique beast.  Not only are they subject to the same buy/sell forces that are exerted on fixed income investments simply because they are a fixed income investment, but traders who buy and sell MBS also must consider a number of secondary and tertiary factors that may make MBS look like a better or worse investment compared to treasuries.  For instance, these traders demanded a much higher yield premium versus treasuries in the wake of the brunt of the subprime meltdown.  Conversely, at the current point in time, where treasuries are returning near 0% inflation adjusted returns, investors do not require so much "arm-twisting" to get on board with MBS.  Hey, if they can get a better than 0% inflation-adjusted return, who cares as much about the relative risks as long as Mortgage market is not imploding as was the perception in mid 2006.

So you will be able to note on the graph below a section that is shaded in a tan color.  This time period coincided with the worst of the worst for the mortgage meltdown.  During this period, the "savvy" market-mavens who, thinking they were so "ahead of the curve" because they had the "secret data source" of every movement in the 10 year note ostensibly coinciding with similar  movements in mortgage rates, were undoubtedly a bit hot under the collar to find that as the treasury yield dropped, MBS yields rose.  In short, anyone who followed 10 year UST's as an indicator of mortgage rates, believing they had "figured something out," or even relating this phenomenon to clients with the pride that came from believing they could really see market movements before they happened and truly understand the "why," would have not only lost many thousands of dollars of their own income during these months, but also burned their clients in the process, for the sake of an unfounded assumption.

To conclude this is why education is the primary focus of our work here.  We strive to bring you only what we know, to not jump to conclusions about causality and forecasting, and to leave the door open for your own conclusions based on experience and belief.  I share this for several reasons, but one of the most important being the following.  You can never be sure what the market will throw at you.  You can never be smarter than the market.  It is a dynamic and fickle mistress not to be trifled with, and the second you make an assumption or believe you know something without being able to prove it is so, you disable the child-lock on the stove of financial fortune and are liable to get burned.  So in this, an especially volatile market, remember that we are dealing with large financial transactions, and not with a no-stakes online poker game.  If you're going to act on an assumption, be sure that it is well founded, and remember that floating only has a 33% chance of paying off overnight (1/3 of the time rates will improve, but the other 2/3rds they will either stay the same or worsen).  Of course with each new day, we can almost always float as we can see reprices coming with enough warning to get our loans locked (usually).  But this is still a gamble to an extent, and the following graph is presented to remind you of just how wrong things can go if you had been one of the ones that made to false assumption that mortgages would follow treasuries.

It's not for nothing that we point this out as well to illustrate the point that this blog will serve your purposes infinitely better than "going it alone" as we make the extra investments to have quality MBS data, and furthermore, to deliver it to you in a tangible format.  In the coming months we will be attempting to take our content to an even higher level and will be relying on our readership for feedback and guidance as to how we can be the best business partner possible.  Any interim thoughts, questions, suggestions, etc... may be directed to info@mortgagenewsdaily.com.  Until then we hope you are enjoying the blog, and the bumpy, eventful, even if not always enjoyable "ride" that we are all on together.  Without further ado, here's your graph:

The red line is the 6.0% MBS PRICE and the blue line is the 10 year treasury PRICE (so as these lines go down, the rates would be going up).  Notice mid 2006, right about the time the excrement hit the fan in the mortgage market what happened as investors became afraid of mortgages and decided to put their money elsewhere!