MBS MID-DAY: 8/8/2011

Ranges had been fairly tight and contained until the domestic stock markets opened. It's not like the things hadn't already been trading in futures, but regardless of S&P downgrades, it's common to see bonds trading with a bit of reservation ahead of stock's cash market open. The gains weren't an immediate "9:30 AM Thing," but rather came into the picture right as stocks turned negative, sort of giving us a clue that bonds are watching and responsive. The improvements took 10 yr notes down into the 2.43's and Fannie 4.0's are up 15 ticks on the day now to 102-31, basically in the middle of Friday's pre-noon range (mean and median based on eyeball calculations). With the previous caveats about lender response to uncertainty/volatility, this is a net positive for rate sheets, though could increase the delay since it's a relatively spiky movement in the context of the more narrow morning.

The S&P downgrade is an x-factor that adding more volume and volatility to today’s economic-data-free trading. The short term effects may be a surprise to some. The same debt that was downgraded is rallying. 10yr notes are up 21 ticks in price, down 7.2bps in yield to 2.4904. Counterintuitive perhaps, but the justifications for it have been making rounds for weeks. Those can mostly be distilled into three key components. 1) Even at AA+, is there better safe haven than US TSY'S? Especially with #2? 2) European debt contagion is more important to TSY trading than the fallout from the downgrade. It’s very huge and very ugly. (Think 3% + yields in the absence of EU Drama). 3) The Biggest Loser here is Stocks, giving TSYs even more of a lift. Whatever yield hike you want to talk about as a result of the downgrade, by the time you balance it with the yield drop in response to those two factors, you're looking at a fairly nominal reality with 10yr notes not as low as they were early Friday morning, but neither are they as high as they were on Friday Afternoon. Right about mid-range. The frustrating thing in the short term pertains to the "safe haven" concept, the seeking of which sometimes explained as "risk-off." Sadly, MBS are more risky than TSYs. Sad for today anyway where risk is noticeably out of style. So versus the 20+ ticks of price gains in 10's, Fannie 4.0s are up only 5 ticks at 102-22. The underperformance of MBS is to-be-expected this morning, and should be progressively less severe moving forward. If lenders price rate sheets exclusively based on MBS levels, things could be OK or even slightly improved this morning. If lenders go an extra step or two and pay attention to the volatility and uncertainty, rate sheets could be worse. The bottom line, one with which we'll have to become rapidly comfortable, is that it's a "wait and see" environment for now, but at least the seats are less painful than many had feared.