MBS RECAP: Decent Treasury Rally, but MBS Underperform

MBS Pricing Snapshot

Rather than being decidedly weaker, bond markets are expressing some indecision at the moment and that could be good for MBS's previously elevated reprice risk.

After having completely evaporated from 2:04pm through about 2:15pm, some bid-side support has cautiously crept back into MBS markets. Supportive undertones courtesty of 10yr yields breaking back below the 1.99 pivot.... Granted, the bounce back above 103-24 in Fannie 3.5 MBS wasn't "quick," but at least it has happened.

Prices are holding there at the moment. Volume is lightening up. 10's are putting up a good enough fight around 1.99 and a sufficient amount of MBS buyers have finally surfaced to help us avoid tragedy.

-No clear trend at the moment
- just sideways grind into 3pm TSY close
- Slight negative reprice risk persists for some lenders, but looking less dire than it was.

If you read the "concerns" in the last few alerts, they've been like a series of mini-prophecies for current action. We just got our most convincing break of support in MBS as Fannie 3.5's moved under 103-24 and currently trade at 103-22--definite reprice risk territory for some.

10yr yields are pushing 1.99 and a "turn" is looking more and more possible. The more it bears out, the greater the reprice risk, but the "early crowd" could be in any time unless MBS bounce QUICKLY back over 103-24. As for now, the bid has left the building.

As feared, the window of opportunity for selling pressure has resulted in, well..., selling pressure.

MBS broke below our first level of interest at 103-27 and look as if they may be headed below the more clearly delineated reprice risk level at 103-24. That said, EVEN NOW, the recent losses with respect to the day's broader trading range make it seem that negative reprices are probably taking over as more likely than positive reprices. In other words, there's some slight risk already.

But so far, the selling pressure has been met with a sideways grind around support levels, but keep a close eye out here. If the support breaks down, reprice risk increases if we fall under under 103-24.

We'd hoped/expected to see volume pick back up today and it hasn't disappointed. 10yr Futures contracts, one of our favorite proxies for broader bond market volume, are over 1.1 million on the day and rising. Looks like we're on pace for the most active session since mid March.

To make matters better, the volume has been taking yields lower and prices higher in bond markets and MBS, though it should be noted that decent chunk of the positivity is due to traders who had been betting on rising yields getting forced to cover those short positions as their predetermined "stops" are hit.

Just like snowball selling is self-sustaining, so too is snowball buying to an extent. Eventually, the market will eat up enough of the remaining short positions (folks who were betting on higher rates) and it will slow down, and probably bounce back higher as those same folks "re-short" the market at lower yield levels. Whether it's 1.97% in 10yr TSYs or 1.93-1.95, we don't know yet and actually, we can't say it will certainly happen.

What we can say is that if we see a bounce back higher in yield, the next 40 minutes is the first great window of opportunity today. The 3yr auction and both Fed buybacks would be out of the way. The long end of the curve is already starting to steepen up a bit, and accounts may start discounting tomorrow's 10yr Note Auction.

So we'd be a bit guarded against the bounce here. We wouldn't be too concerned to see one, but would just want to pay attention to how it develops. First short term technical support at 1.99 in 10's and then almost like clockwork on the round numbers higher in yield (2.0, 2.01, 2.02) until reaching the more serious support in the 2.04's.

We'd start eyeing MBS prices if they fell below 103-27, with negative reprice concern ramping up if they broke below 103-24 (Fannie 3.5s).

MBS are at the highs of the day and it's starting to feel like we might soon see a reprice or two for the better, even though such things are generally less likely on "roll" days. Reasons for the strength were just discussed in the MBS MID-Day, excerpt and link below:

" As European markets continue to weaken into their close, bond markets continue to benefit from that flight-to-safety.  Volume has returned in grand fashion and it's all driven by tradeflows as opposed to economic data.  Newswires and trading updates have been coming in all morning indicating weakness in the European periphery.  Italy... Spain... Take your pick.  Spreads between those counties' debt and German benchmarks have gapped out to multi-month highs.

"The ingredients have been pretty simple and the result fairly logical...  We had dormant markets that knew they would be trading in higher volume today, domestic markets waiting to see how Europe would trade after their long weekend, overnight European trading generally confirmed the range break below 2.07%, Spanish debt concerns caused additional German Bund rallies in the EU, that forced the hand of domestic accounts who'd either been waiting for those European cues or who simply got "stopped out" as yield levels were hit that forced them to abandon their short positions (aka "short covering").