Mixed Rate Outlook Provides Perspective: Risk Greatly Outweighs Reward
I sat down to write "The Week Ahead" last night and drew a blank. Not that it was a tedious task outlining the events that held the potential to move mortgage rates, that was the easy part. My frustrations arose when formulating an outlook. Allow me to think out loud for a moment...
We've just come off a week that ended with a scary sell off, but that sell off wasn't exactly unexpected though. The "rate sheet influential" end of the yield curve was/is extremely overbought and positions skewed largely toward the LONGS . If not for pure position squaring purposes, Treasuries were due a correction and it happened.
The bond market is clearly still searching for directional guidance though. This is evident via added chopatility around econ data, specifically at the price highs and lows. It is also obvious via a shift in trading flows. To put that in Plain and Simple terms: the number of buyers and sellers are equaling out after a long period of buyers dominating the Treasury market.
Call it profit taking, call it reducing exposure, call it balancing out the portfolio, call it a falling knife that no one wanted to catch on a summer afternoon....whatever you call it, the behavior exhibited by the bond market on Friday was not indicative of a major shift in interest rate bias. This was not duration shedding. The economic environment is muddied with an unusual amount of uncertainty and downside risks still outweigh the potential for sustained economic growth. This sentiment is supportive of low bond yields for an "extended period", which leaves me feeling indecisive about the extent to which benchmark yields can go higher.
But then a big sticky note on the top of my monitor reminded me: IT'S A TRADER'S WORLD AND WE'RE JUST LIVING IN IT. With this type of strategery (that word makes me laugh every time I see it) moderating the bond market's motivational tendencies, weak fundamentals may only apply when traders need justification to maintain or build on profitability. If I were to base my outlook purely on trading positions, I would point toward the pain trade. The majority of the TSY market is still way long the long end of the yield curve. This gives the street another opportunity to catch folks offside. What's that old adage?
The market looks to prove as many people wrong as possible!
If the pain trade plays out, Treasury prices will move lower and yields will rise. How far? The PANIC ZONE offers support at 2.75%. Beyond that, 10yr yields are free to run as far as 2.85% before finding firm support again. If econ data is bond market supportive and rates go lower, the first line of resistance is not far below at 2.50%. Through that pivot is another gray area where choppy price action could take 10s all the way down to 2.40%.
re: mortgage rates
We've seen benchmark yields rally down to the levels needed for mortgage rates to move below 4.25%. And while some lock desks are cautiously meddling in 3.5 MBS coupons and offering 4.00%, most lenders won't go any lower than 4.25%. Plus, the aggressive manner in which 10s rejected 2.40% last week implies we've likely seen benchmark 10 year note hit an intermediate yield low, at least until the next FOMC meeting on September 21. From that perspective, I think we can state one thing with some certainty: MORTGAGE RATES HAVE FOUND A BOTTOM
My point: We've likely seen Treasury prices hit their highs and Treasury yields hit their lows. With MBS showing no inclination to keep up or catch the Treasury rally, we've probably seen mortgage rates hit their lows as well. After reprices for the better today, loan pricing is 13.3bps better than it was last Monday (on average). Loan pricing is just about as aggressive as it's ever been! If you are a perfect borrower, 4.25% is readily available. Heck, even if you're not a perfect borrower 4.25% is available with points. While you may see a few bps here and there...floating your loans right now doesn't seem logical...the risk/reward relationship is highly skewed toward all risk no reward.
Now for some good news. Sort of....
First, I am not saying rates WILL RISE as much as I am pointing out that I feel we've seen a bottom.
Second, production MBS coupon yield spreads have ticked wider and wider since August settlement as MBS were left in the dust by the latest Treasury rally that took 10s down to 2.40%. "Rate sheet influential" MBS coupons are officially oversold! If Treasuries do sell, MBS prices will fall, but at a slower pace than their duration adjusted guidance givers. This implies, if benchmark yields go up, mortgage rates will go up too, but not quite as fast (if TSYs sell off in an orderly fashion). Also, because positions are still so heavily skewed toward LONGS, if rates do rise, there should be an opportunity to lock when the bond market looks to retest any sell offs like it did today. This isn't much of a consolation, but if you're that worried about short term pricing you shouldn't be floating anyway.
READ MORE ABOUT YIELD SPREADS.
The October delivery FNCL 4.0 went out +0-18 at 102-30....recap to follow in AM. Tomorrow is the last day of the month, that means supportive index extension buying! READ MORE ABOUT MONTH END INDEX EXTENSION