MBS RECAP: 2/16/2011

(Dow Jones)--A depressed housing market has been an intractable legacy of the financial crisis, but economist Robert Shiller--who famously presaged the housing bust--says speculative activity could lead to a new bubble. While cautioning that housing prices are more likely to "stay in the doldrums for years," Shiller sees an alternative scenario in which the sector's deep correction could overshoot on the way back up. "People are much more speculative, so there is a possibility of another housing bubble," the Yale University economist told Dow Jones in an interview this week. Government policies that continue to encourage lower and middle-class home-ownership are also part of the problem, he added. "It's possible that in a few years it gets cleared out and it's off to the races again," he said. "This is not my forecast, but it could happen." However, Shiller thinks the housing sector has a long way to go before that scenario unfolds. Recent data from real-estate website Zillow.com illustrated that home values have plummeted 26% from their June 2006 peak--worse than the approximately 25.9% seen during the Great Depression. "Home price bubbles of such magnitude are rare," Shiller said. "This national bubble was a big anomaly and it might not happen again for several years." As a result, the overhang currently being experienced by the market will be particularly hard to shake, he added.

Although the initial move following the FOMC minutes was a negative one for bonds, benchmark 10yr treasuries were able to hold on to previous support levels at 3.65 and have since moderated to 3.621. FNCL 4.5's are up several ticks from their lows back into more traveled territory at 100-25. For now, it looks like many lenders will be able to forgo repricing for the worse.

The minutes of the Jan.26-27th FOMC meeting have been released. The minutes note that Board members are becoming more confident on the prospects for an economic recovery but remain defensive of anemic growth in the labor market. The Board recognizes the potential for rising energy and food prices to creep into core inflation metrics but says underlying trends indicate inflationary pressures remain subdued. On the topic of QEII, a few members were unsure of the program's impact but felt changes were not appropriate at this time. If consumer demand sustains a rapid recovery pace, the Fed will be forced to reconsider their expansionary monetary policies. Downside risks include a structurally weak jobs outlook, a stagnant housing market, and headline risks associated with European debt and U.S. municipal bonds. In their discussion the Fed did speak on one of MND's hot topics, high levels of productivity and anemic wage growth. Quote, "Available measures of labor compensation showed that labor cost pressures were still restrained, as wage increases slowed along with inflation and productivity gains appeared to remain substantial." MND believes this is a sign of a structurally impaired labor market that when combined with rising living expenses will only serve to reduce consumer spending in the year ahead (margin squeeze).

Any time MBS push down to new lows, we have to entertain the risk of reprices for the worse. There have been a lot of alerts today, but volatility has been high. Though this live update will be filed as an alert, the post FOMC minutes bond market story is far from over. The initial reaction is not great. 10yr notes have risen in yield to test recent highs from this morning, but so far have not broken them. FNCL 4.5's are at their lows of the day, but only by a tick, currently down 9 at 100-22. The longer that 3.65 holds, the better the chance that it will continue to hold, which will hopefully pacify the MBS market to a sufficient extent to make some gains back into this morning's range. But if 3.65 is broken, MBS losses may well continue.

FNCL 4.5's are currently down 7 ticks on the day at 100-25, close to the lowest levels of the day after the geopolitical flight to safety bid came and went. 10yr notes are at 3.625 and would be hoping to break into the 3.59's if markets see hints that inflation is under control and no ramping up of indications of short term rate hikes.

10yr notes have backed up quickly, reaching 3.631 from 3.58+ in just a few minutes. FNCL 4.5's are at their lows AGAIN at 100-24. That means reprice risk is back AGAIN! Yes, it's a volatile day, and it's not over yet with FOMC less than an hour away!

In recent news, Israel said that two Iranian warships planned to sail through the Suez which the Israeli PM called a provocation. Bonds have benefited from this geopolitical drama with the 10yr now ticking under 3.60 and MBS rapidly rising to 100-28. This alleviates previous reprice risk.

Reprices for the worse are a serious risk once again as MBS widen versus treasuries and FNCL 4.5's tick down to the lows of the day at 100-24. The 10yr note by comparison is mid-range at 3.619.

The Bank of England will probably not hike interest rates until the fourth quarter of this year but the proportion of analysts expecting an earlier move to curb soaring inflation is rising, a Reuters poll showed on Wednesday. *** REUTERS POLL-BOE SEEN RAISING RATES TO 0.75 PCT IN Q4 (SAME AS FEB 9 POLL) *** 10 OF 50 ANALYSTS SEE BOE HIKE BEFORE JULY (8 OF 71 IN FEB 9 POLL) *** 22 OF 50 ANALYSTS SEE BOE HIKE BEFORE OCTOBER (24 OF 70 IN FEB 9 POLL)

Although the10yr yield did creep up to 3.65, it put in more high side bounces around 3.64 and has since fallen to 3.625. This is "close enough" to consider support to have held, even if only by the skin of its teeth. FNCL 4.5's are back at their pivot point of 100-26 in FNCL 4.5's which reduces risks of widespread reprices for the worse.