MBS MID-DAY: 1/27/2012

• RTRS – Fed’s Dudley says much work remains to achieve Fed's dual mandate of employment, price stability
• RTRS - monetary policy will continue to do its part to support recovery
• RTRS - action on housing, fiscal policy also needed for recovery
• RTRS - pace of recovery remains sluggish, likely to slow somewhat in 2012
• RTRS -says expects moderate growth this year, but risks are skewed to downside mainly due to Europe
• RTRS – U.S. economy continues to operate with 'significant excess slack'
• RTRS - slack is putting downward pressure on trend inflation, which may be headed lower
• RTRS - says unemployment likely to remain unacceptably high for near term

The Consumer Sentiment Index for the month of January improved slightly to 75.0 from a preliminary reading of 74.0 according to University of Michigan/Thomson Reuters Survey--the highest level since February 2011.

The current conditions component rose slightly more than expected, coming in at 84.2 vs a 83.0 expectation and 82.6 in January. Expectations edged up to 69.1 from 68.4, roughly matching the 69.0 estimate.

Inflation expectations remain in check with the 1yr expectations moving up .1 and 5yr expectations down .1.

All in all, none of the reports components are far enough away from expectations or previous readings to elicit much of a market response. The biggest volumes of the day were seen just after GDP and any movement related to the Sentiment release is barely discernible. Trading will grow increasingly quiet unless acted upon by a sufficient force. Candidates for that seem mostly limited to unexpected/unscheduled headline-type market movers. Failing that, stocks and bonds might do a little tango as each look to the other for some guidance amid the lack of data. Price/yield movements are of little consequence at this point unless volumes surge.

Attorney General Eric Holder and other officials will announce the formation of the Residential Mortgage-Backed Securities Working Group TODAY, Jan. 27, 2012, at 11:30 a.m. EST.
The President this week directed Attorney General Holder to collaborate with several state attorneys general and other federal entities to investigate those responsible for misconduct contributing to the financial crisis through the pooling and sale of residential mortgage-backed securities. This working group will be operated out of the President’s Financial Fraud Enforcement Task Force, which is chaired by Attorney General Holder.

The December Mortgage Monitor report released by Lender Processing Services (NYSE: LPS) shows mortgage originations continued their decline from 2011's September peak, down 10.1 percent from the month before. At the same time, those loans originated over the last two years have proven to be some of the best quality originations on record. Likely a result of tighter lending requirements, 2010-11 vintage originations showed 90-day default rates below those of all other years, going back to 2005. December origination data also shows that recent prepayment activity - a key indicator of mortgage refinances - has remained strong, with 2008-09 originations, high credit score borrowers and government-backed loans having benefited the most from recent, historically low interest rates.

With growth coming in not only a bit tamer than forecast, but also owing more than 2/3rds of the gain to inventories, bond markets' initial move was a positive one. At first, bond markets showed more indecision about trading levels following the release, merely putting in supportive bounces to stand against the small amount of weakness we had coming into the session. Things are just a bit better now with 10's tapdancing around unchanged levels and MBS hitting multi-month highs. But, it's not a runaway rally yet, and might not be at all today. Still a bit too early to tell.

MBS are up 7 ticks to 103-23 (all time highs 103-29) and 10yr yields are down about a bp currently at 1.9278

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 2.8 percent in the fourth quarter of 2011 (that is, from the third quarter to the fourth quarter), according to the "advance" estimate released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 1.8 percent.

The Bureau emphasized that the fourth-quarter advance estimate released today is based on source data that are incomplete or subject to further revision by the source agency. The "second" estimate for the fourth quarter, based on more complete data, will be released on February 29, 2012.

The increase in real GDP in the fourth quarter reflected positive contributions from private inventory investment, personal consumption expenditures (PCE), exports, residential fixed investment, and nonresidential fixed investment that were partly offset by negative contributions from federal government spending and state and local government spending. Imports, which are a subtraction in the calculation of GDP, increased.

The acceleration in real GDP in the fourth quarter primarily reflected an upturn in private inventory investment and accelerations in PCE and in residential fixed investment that were partly offset by a deceleration in nonresidential fixed investment, a downturn in federal government spending, an acceleration in imports, and a larger decrease in state and local government spending.

MBS are opening 2-3 ticks lower; S&P futures just slightly higher, but generally followed bond markets overnight. Volume in the overnight session was just under recent averages but respectable overall. 10yr Treasuries rose as high as 1.9681 after a relatively strong Italian debt auction. Beyond that, there was no major driver of trade as it seems bond markets have opted to shy away from overly aggressive bullish breakouts and are perhaps waiting for this morning's GDP, next week's NFP, or resolution to Greek bond-swap talks that may come some time in between. With respect to that, there's a headline making rounds that the EU's Rehn "expects a resolution" by this weekend, but seriously, what else is he going to say? These talks with and about private investors have been going on for what seems like an eternity and when Greek officials are saying they're close to a deal, how much of a stretch is it for any other Euro-zone official to simply say they "expect a resolution?"

In terms of levels, MBS and Treasuries both had big 2-day double bounces at resistance levels (ceiling for MBS, floor for 10yr tsy's). For Fannie 3.5's, that's a thin band of prices around 103-16. Supportive pivots lay at 103-11, 103-06, and 103-00. 10yr yields hit 1.92 for a second time in two days (to be precise, 1.916 on Wednesday and 1.923 on Thursday). Technical levels of note are all over the place depending who you ask, but 2 bounces in 2 days seems to suggest some sort of resistance event is taking place at 1.92. Overhead, the 1.95 zone is noisy, but there's a long-standing and more clearly defined pivot at 1.98--think of that as the first line of defense if things go south--followed by 2.00. On the other hand, if we're rallying, 1.87 and 1.84 seem like the first two likely pivots. We have no idea where MBS would go from 103-16, but we do know that all time highs aren't far overhead at 103-29.