MBS RECAP: Poor Performance

(Reuters) - Economic growth slowed in much of the United States in June and early July, the Federal Reserve said on Wednesday in a report that cast doubt on a pickup in activity in the second half of the year. The Fed's Beige Book summary of economic conditions across the country said eight of the nation's 12 Fed districts reported moderating growth. The Fed report and Wednesday's data on durable goods orders that showed weak business spending plans in June suggested a tepid recovery is not gaining momentum as economists had anticipated. "Economic activity continued to grow; however, the pace has moderated in many districts," the Fed said. The glum report, which covered the period through July 15, showed a recovery spinning its wheels rather than gaining traction. While most districts saw modest hiring increases, labor market conditions remained soft, the Fed said. Home sales were little changed since the Beige Book issued in early June and most districts reporting on home prices found them flat or declining. Against that backdrop, wage pressures were subdued and prices pressures moderated somewhat, the Fed said.

The Beige Book is not one of those reports that has a clearly delineated "consensus" and "official result." As such, the period over which we see reaction to that report is a bit spread out, unless it contains something utterly unexpected. So far, the reaction is just positive enough to be identified as such, but doesn't step into the realm of major corrections. Before the auction, MBS had largely perched on or above 100-10 and moved down to 100-05 leading up to the auction. Post-Beige-Book, we currently have regained those losses and are back to 100-10. Just keep it in perspective though, it's the difference between losing half a point on the day and "only" .375 if we close right here. Sadly, even that's not guaranteed. All of this dreary borderline pessimism means that there's a similarly pessimistic outlook for these small gains to motivate reprices for the better. It's certainly not out of the question among a small group of aggressive lenders, but it would be the exception and not the rule at current price levels. Perhaps though, it is a bit more likely that the negative reprice outlook from earlier is now at least neutral.

The Federal Housing Finance Agency (FHFA), as conservator for Fannie Mae and Freddie Mac (the Enterprises), has filed a lawsuit in the federal district court for the Southern District of New York against UBS Americas, Inc., and related defendants alleging violations of federal securities laws in the sale of residential private-label mortgage-backed securities (MBS) to the Enterprises. FHFA seeks to recover losses and damages sustained by the Enterprises as a result of their investments in UBS Securities. The lawsuit alleges that UBS Americas made numerous material misstatements and omissions about the mortgage loans underlying the private-label MBS, including the creditworthiness of the borrowers and the quality of the origination and underwriting practices used to evaluate and approve such loans. The defendants also failed to conduct adequate due diligence. This lawsuit seeks to recoup the losses suffered by the Enterprises related to their $4.5 billion investment in securities sold by UBS. As conservator of Fannie Mae and Freddie Mac, FHFA is charged with preserving and conserving the assets of the Enterprises. Through this lawsuit and additional lawsuits expected to follow, FHFA seeks to recover losses suffered by the Enterprises in connection with the Enterprises’ investments in private-label securities. “FHFA is taking this action consistent with our responsibilities as conservator of each Enterprise,” said FHFA Acting Director Edward J. DeMarco. “From the issuance of 64 subpoenas last year to the filing of this lawsuit and further actions to come, we continue to seek redress for the losses suffered by the Enterprises.”

MBS and Treasuries were so much weaker even before the auction that the weaker results haven't done what they otherwise might in terms of causing further bond market losses. For instance, if MBS and Treasuries were unchanged on the day, we'd be looking at a a steep sell-off after the auction, but since we already did that this morning, there's not much more adjustment needed. Fannie 4.0's are just a touch about their lows of the day, currently down half a point at 100-06. 10yr notes have risen slightly, but are still under 3.01, and don't look to be threatening more serious technical levels around 3.03. So it's "so far so good" following this auction, assuming you already came to terms with the "bad" from earlier today. Beige book may still move markets to some extent today. But debt-ceiling headlines are starting to look like the most popular market mover for now.

You might say today's auction is weaker by an "logically incremental" amount. In other words, we know that the longer the maturity, the more impacted a Treasury security is by the current debt debate. Therefor we'd logically expect today's auction to be weaker by a similar amount to which 5's are more challenging this week in general. Any way you slice it, today's was a bit worse than yesterday's. The high yield of 1.58 was 2 bps higher than the WI (when-issued: can be thought of like the estimate of where traders think the auctions high yield will come in). This is in contrast to the stronger showing from yesterday's high yield that was LOWER than yesterday's 1pm WI yield. Demand was weaker than recent averages as well, at 2.62 bid-to-cover versus a recent average of 2.84. Bid to cover is the amount of dollars bid for each dollar auctioned. 2.62 is noticeably weaker, but not disturbingly so, especially this week with raging debt ceiling debates and first 5yr note auction post QE2.

While the magnitude and fast-pace of the MBS price movement may be very much in line with the morning's previous fluctuations, this selling spree comes AFTER several lenders (maybe "most") are out with rates for the day. Any lender who didn't price very defensively is in-bounds as far as reprice risk is concerned. 4.0's are down 10 ticks on the day now at 100-12. Given the volatility, we don't imagine a majority of lenders will reprice now, but it's at least a possibility.