Lock Desks Buy Back Hedges. Potential Shift in Production Coupon Looms

Yesterday we heard banks were buying back MBS hedges. This means lock desks were actively reducing their pipeline coverage (forward hedges) to account for an expected increase in fallout. More fall out = less deliverable loans = added hedging costs unless you replace the production with similar paper before settlement,  READ MORE 

Looking back, this was a hint of strong pricing to come. Just in case you haven't seen the headline yet, this is what we told consumers today: ATTENTION: Mortgage Rates Hit New Lows

I actually felt the need to apologize to retail L.Os in that post because I know those headlines might make their lives miserable. It is what it is though, the FNCL 4.0 hit a new price high and loan pricing reflects it. On average, rebate was 30.2bps better vs. yesterday.  HERE is a full comparison.

I mentioned earlier in the day that 3.5s were trading forward. What I did not say is 3.5s were trading forward IN SIZE. They aren't! That's because secondary managers are cautiously adding 3.5 hedges/coverage as needed while negative convexity remains a legitimate concern and the TBA market is in need of structured cash flows with a longer life.(longer duration like 3.5s and 4.0s). While the reduction of coverage (4.0s) and improvements in rebate imply we are on the verge of potential shift in production coupons... to the 3.5...the bond market still needs to play along. READ MORE BUT IGNORE MY COMMENT RE: MORTGAGE RATES AT A BOTTOM (I was wrong!)

RISK REPORT...

Because it is possible to deliver a 4.25% note rate into a 4.00% or 3.50% MBS coupon, especially with more and more folks retaining servicing, 4.25% quotes will stay on the board even if "rate sheet influential" MBS back away from newly hit price highs. With that in mind, if you're floating 4.25% in hopes of more rebate, the risk of you losing the quote all together is minimal, you are only gambling with your paycheck and your pride. 

Note rates below 4.25% can only be delivered into 3.5 MBS though. That makes 4.125%, 4.00%, and 3.875% quotes much more sensitive to rising rates/falling MBS prices. If you can execute a lock under 4.25%, do not get greedy because it's possible you might lose the rate all together. Pigs get fat, hogs get slaughtered.

BEST EXECUTION STRATEGY: If possible, lock 4.25% 0+0. If rates rise you look like a genius. If rebate improves further and mortgage rates move lower, renegotiate if necessary. It's a win/win situation....

Tomorrow I will discuss the mention of further Federal Reserve MBS Purchases in the FOMC Minutes.