Street Stuck with Extra Inventory After Latest POMO. Reprices for Worse Possible

The 10yr note yield just shot up from 3.228% to 3.271% for seemingly no reason. Then I got my POMO email alert from the FRBNY and it made more sense...

The Fed focused their QEII Treasury coupon lifts today on notes maturing between 6/30/2016 and 11/30/2017. This is the belly of the beast, where the QEII pain trade stung the most. Thus it would make sense to see the street doing it's best to dump their "belly of the beast" holdings onto the balance sheet of the Federal Reserve before year end. There are two observations to call attention to here...both of which played a role in yields jumping. 

In the previous POMO that centered on 2016 to 2017 maturities, dealers only offered $30.1 in supply. In today's POMO, dealers offered $33.1 billion. The Fed bought the same exact amount today as they did on December 1st....this left an extra $3 billion on the street's book.

Not only did they leave an extra $3 billion on the table, they bought a considerably large chunk of 3.125% 4/30/2017 coupons. This would imply one dealer (or a few in cahoots) was particularly aggressive in their willingness to get rid of inventory, even if they had to do so at an extra discount. The Fed isn't gonna pass on cheaper offers! This stole demand and left the rest of the street sitting on more inventory than anticipated ahead of the $30 year bond auction.

Rate sheet influential MBS prices are moving lower and spreads are inching wider ahead of the 30 year bond auction. Lower and wider = localized selling in production MBS coupons. Fannie 4.5 are 8 ticks off their AM price highs.Fannie 4.0s are 8 ticks off intraday price highs. Some lenders may be plotting a reprice for the worse.