MBS RECAP: Positive Reprices Reported

After the initial post-auction rally, Treasuries began to give back a small portion of the gains, but were soon able to reverse course and have now made it back in line with their best levels of the day. MBS have also reached their highs with FNCL 4.5's currently at 103-17. Not only that, but these levels have been held with a boring degree of volatility. MBS haven't deviated by more than a tick or two since auction time. That's been good enough for us to see more than a few reprices for the better and possibilities remain that we'll see more.

This isn't surprising because econ forecasters generally display herding mentality when offering outlooks, but these downgrades are developing into a trend. We call it a market-wide correction of "false start assumptions" and we believe there are are more outlook corrections to come (WSJ) - While Macroeconomic Advisers still expect second-quarter GDP to come in at 3.2%, J.P. Morgan economists have just downgraded their forecast well below 3%: From Bloomberg: "The U.S. economy will probably grow at a 2.5 percent annual pace in the second quarter, less then a previous estimate of 3 percent, according to a revised forecast by economists at JPMorgan Chase & Co. in New York." “The main factor behind our revision is weaker output of the auto vehicle sector,” JPMorgan’s chief U.S. economist Michael Feroli wrote in an e-mail note. Part of the slowdown in production is due to supply disruptions stemming from the earthquake and tsunami in Japan, he said. There’s nothing magical about the 3% level, but it may have some psychological value as a rough measure of “trend” economic growth. The average annual GDP growth rate over the past 30 years is 2.7%. It remains to be seen whether the market is priced for such growth in the second quarter. The consensus is still for a bounce-back from weakish growth in the first quarter and then a second-half liftoff.

(Reuters) - St. Louis Federal Reserve Bank President James Bullard said on Tuesday the Fed is unlikely to immediately reverse its ultra-loose policy when its bond buying program ends in June. "A pause give the committee more time to assess economic conditions," Bullard said in remarks that mirrored ones he made on Monday. During a hiatus, the Fed could be expected to hold rates near zero, roll over maturing securities to hold its portfolio at a steady size, and continue to pledge to hold rates exceptionally low for an extended period, the St. Louis Fed chief told a Rotary Club lunch. Bullard, who is not a voter on the Fed's policy-setting Federal Open Market Committee, is considered a centrist on the spectrum of Fed views on the urgency of tightening conditions to keep inflation in check. He said on Monday heightened concerns about European sovereign debt pose a risk to the U.S. economic recovery. Bullard also renewed his call for policymakers to place less emphasis on measures of inflation that strip out volatile food and energy costs. While policymakers traditionally focus on underlying inflation as a better gauge of where prices will be in the future, doing so puts the Fed at risk of appearing out of touch with reality by overlooking the burdens surges in energy and food costs are placing on ordinary Americans, Bullard said. (Reporting by Mark Felsenthal; Editing by Neil Stempleman)

WASHINGTON, May 24 (Reuters) - Two regional Federal Reserve banks again sought a modest increase in the rate for emergency bank loans but were overruled by those wanting no change, minutes of Fed Reserve board meetings in March and April showed on Tuesday. Directors of Federal Reserve banks in Kansas City and Dallas sought a 0.25-percent increase in the discount rate, but the other 10 regional Fed banks argued the rate should be left at 0.75 percent. The U.S. central bank's board sided with the majority. The Kansas City and Dallas Fed banks have for months sought to raise the discount rate to 1 percent as a step toward moving the spread between it and the benchmark federal funds rate closer to pre-crisis levels. Indeed, Kansas City Fed President Thomas Hoenig has been the only top Fed official to call for an increase in the fed funds rate itself since the central bank cut official borrowing costs to effectively zero. The minutes showed lingering worries about a lackluster recovery. "Federal Reserve Bank directors generally noted that although the economic recovery was progressing, they were cautious about the economic outlook," the minutes said. Some directors saw upside risks to inflation, while others believe higher energy and commodity costs -- coupled with efforts to slash government spending -- posed more of a threat to consumer spending. "Risks included rising commodity and energy prices, which had the potential to dampen consumer spending, and increased fiscal stringency at all levels of government," the minutes said. ((For more stories on Fed policy go to FED/AHEAD)) (Reporting by Pedro Nicolaci da Costa; Editing by Neil Stempleman)

Treasury just auctioned $35 bln in new 2yr notes at a high yield of .560 versus a when-issued yield of .554. Though the high yield did "tail" a bit (come in higher than the WI), the demand was good at 3.46 BTC vs a 5 auction average of 3.286. Other components were in line with recent averages including the 31.1% taken down by indirect bidders. At first there was almost no perceptible movement in TSY yields or MBS prices following the auction, but we've seen 10yr yields come down a few bps now and FNCL 4.5 MBS are up to 103-15. These are the highest levels of the day and any further progress from here or even just an extended time spent at these levels or better could result in reprices for the better from the "early-to-act" lenders.

With the 2yr note auction only 20 minutes away, it's not a major surprise that Treasury yields are less-willing-than-usual to follow slumping stock prices. Even though the S&P is now down to 1316.83 on the day from a high of 1323+, 10yr yields are only fractionally off their highs of the day, down to 3.152 from 3.162. MBS have been a bit more even-keeled, having not moved more than a tick from their current price in FNCL 4.5's at 103-12. The auction results remains the biggest and best candidate to cause more significant movement in bond markets today.

(Reuters) - The Federal Reserve Bank of New York on Tuesday laid out the criteria for government sponsored entities (GSEs) to join the roster of counterparties it could eventually tap to drain cash from the financial system. The New York Fed, in laying out the criteria for GSEs as eligible counterparties to participate in reverse repos, said that among other things the GSE must be chartered by the U.S. Congress, and "be a consistent cash investor in the tri-party repo market ... with an average daily outstanding amount of reverse repo transactions of at least $15 billion for the past three months." Although the New York Fed did not mention them directly by name in a statement on its website, the criteria is most likely to include the U.S. mortgage financing agencies Fannie Mae and Freddie Mac. Reverse repos are one of the tools the Fed has said it can use to tighten monetary policy when needed to help prevent inflation. In a reverse repo, the New York Fed sells securities to financial firms for a set period, temporarily draining excess reserves from the financial system. The New York Fed on Monday added 32 new money market funds to its roster of counterparties. The new funds include the Federated Capital Reserves Fund, BofA Treasury Reserves and the JPMorgan Liquid Assets Money Market Fund.

A raft of data and impending events to consider just hit the TSY market at 11am. This is normally an hour that sees some movement in yields due to the details the Fed's Permanent Market Operation TSY buying that are normally released at this time. In addition, stocks just put in their most convincing bounce of the day, so the stock lever may be having an effect as well. There was also a headline about the World Bank unveiling a $6 bln funding package for Tunisia and Egypt, though it's unclear as to to the extent this is impacting yields. On a final note, there's the 2yr note auction coming up in 2 hours and TSYs have a penchant for building in pre-auction concessions to make for better bid facilitation at auction time. One, some, or all of the above may be pushing yields higher, but the important part of the story is merely that they ARE higher, having moved from 3.14 to 3.16 in the past few minutes. This is effectively in line with the highest yields seen this morning and thus far has only served to drop FNCL 4.5 MBS to 103-12, in line with their lowest prices of the morning. So everything is still within its range today, albeit at the weaker end. We wouldn't even be surprised to see TSYs try to push even weaker ahead of the auction, but for now, we remain contained. Given that the drop in MBS wasn't even 3 ticks, this should not be enough for reprices for the worse (although we DO have ONE outlier reported as having repriced for the worse). That eventuality is more likely to materialize after the auction or if prices move outside the current range.