Rate Techs: Teetering on a Directional Shift
Headline news and crisis scenarios have been the market's primary directional motivation for most of March.
With exception to the Fed's proclamation that our economic recovery may be on "firmer footing", negative events have dominated the news flow. Bond yields and mortgage rates have benefited from a flight to safety as a result. These are just "Big Picture" directional observations though, we can't forget the technical inflection levels that dictated the speed and extent to which bonds rallied over the past month. Investors are now retesting these price/yield pivots to confirm a shift in directional bias.
Let's take a look at where we stand at the moment...
The April FNCL 4.5 MBS coupon recently topped out near 102-25. If you're wondering about the significance of this price level, you don't have to look very far to find it. 102-25 served as range resistance for the first 4-weeks of the year. FNCL 4.5s have yet to confirm a breakdown of this resistance level in 2011. And now range support at 101-28 is feeling the pressure of falling prices. That means "rate sheet influential" MBS coupons are on the verge of a bearish development....gotta hold near current levels to avoid a directional breakdown.
Below 101-28, major support is first found at 101-20 then 101-08. FNCL 4.5s must sustain a rally through 102-25 if C30 mortgage rates are to break the 4.875% barrier.
Where do FNCL 4.0 prices need to be if the 4.875% mortgage rates barrier is to be broken?
The simple anwer: At least over 100-00!
The chart below graphs the price difference between the FNCL 4.5 MBS coupon and the FNCL 4.0 MBS coupon. Right now the price spread between the two is 306bps. The last time we saw lenders hedging with 4.0 MBS coupons the spread was closer to 280bps. 4.0s have caught up lately, but positive progress just stalled near 300bps. A flatter benchmark yield curve would certainly help our cause...but we're gonna need the back month FNCL 4.0 to see a sustained bid over 100-00 before originators head "down in coupon" and the 4.875% barrier is busted. FNCL 4.5s would be hovering close to 102-25 (likely above) range resistance if that scenario played out. READ MORE
The FN 4.5/4 swap trades in ticks but we're gonna present it to you in bps to keep it simple.
Switching over to bencmark 10-year Treasury notes, the main directional guidance giver of "rate sheet influential" MBS coupons, we see a sharp back-up in process. Currently 10s are retesting 3.34% support for the third time in as many days. While holding this level would be a bullish indicator, we view 3.40% as the main inflection point. If 10s failed to stick below 3.40%, trading technicals would lean in favor of the bear camp and a range trade between 3.40% and 3.70% would be on the table. If 3.34% does hold we quickly find resistance at 3.30% and even stronger resistance at 3.22%. Trading between 3.34 and 3.40% would increase our defensive rhetoric but leave us feeling frustrated about offering a directional bias.
To put these pivots in perspective, noticeable progress toward breaking the 4.875% loan pricing barrier was seen last Wednesday when the 10-year note traded as far as 3.18%. Bond investors pushed back pretty hard after that rally....
Zooming out to check-up on our long term 10yr chart, we find a steep downward trend channel has just reversed course and rates are revisiting a key retracement level at 3.31%. This choppy directional behavior is very similar to the headline driven volatility we experienced over the first four months of 2010. Since early December we have thought benchmark 10s were repeating last year's history.....
Plain and Simple: An abundance of negative news headlines have overshadowed signs seen by the Federal Reserve that suggest our economic recovery is on "firmer footing". The end result is an overabundance of uncertainty. Traders are stuck in "wait and see" mode. From that perspective, we're looking for benchmark interest rates to establish a new range, but remain conscious of the market's sensitivity to a headline news driven "flight to safety". What does this mean for mortgage rates? Unless the developing storiews recapped in this post deteriorate further, current mortgage rate levels are about as good as it gets. A sustained bond market rally is needed if real money investors are to move "down in coupon".