MBS RECAP: Major Volatility A No-Show On FOMC Day

MBS Pricing Snapshot

There's an incredibly promising pivot point in play for 10yr yields at the moment. As trading evolves around this pivot point, so too should the general positive/negative sentiment regarding MBS. The level in question is around 2.015 and can be seen as the upper teal line in the chart below.

So far, with a few scary breaks higher, this has been the key line of support today and also acted as notable support and resistance in the past. MBS seem billing to hold their ground as long as this support is being held in benchmarks.

Bottom line, so far so good and disaster seems averted for now, barring any surprising additional questions in the press conference. Most of the volume was seen in response to the release of the FOMC Member Forecasts, and now that Bernanke has said what he was generally expected to say regarding QE3 (i.e. still on the table), markets have what they need to hold their ground.

Scorecard:

- 3 prefer first hike in 2012, unchanged vs last time

- 3 prefer first hike in 2013, also unchanged

- 7 prefer first hike in 2014 vs 5 last time

- 2 prefer first hike in 2015, same as last time

- 0 prefer hike in 2016 vs 2 last time.

As you can see, a slightly more hawkish leaning but not in such a way that puts more emphasis on hiking before the current "late 2014" verbiage. This is "the doves becoming slightly less dovish," as opposed to "doves turning to hawks."

Bond markets are doing their best to shake off these adjustments and doing a fairly good job so far. It now looks like we'll make it to the Bernanke presser with MBS in strong enough territory to avoid major reprice risk (moderate reprice risk remains).

Fannie 3.5's made it down to 103-06 briefly and are back up to 103-11 at the moment. 10yr yields are up to 2.016.

First move has been to the downside. Biggest volume pop of the day, new lows for MBS, new highs for 10yr yields. Potential negative reprice risk, but still no runaway sell-off. More to follow...

Just a few highlights, more in the link below:

GENNADIY GOLDBERG, INTERST RATE STRATEGIST, 4CAST LTD, NEW YORK
"It looks like they left the second half of the statement fairly unchanged, the part dealing with the rates and Operation Twist etc. The market rallied into the statement. The statement should have read a little more hawkish, which is fairly consistent with the previous FOMC statement. The big focus is on the projections and Bernanke."

DAVID ADER, HEAD OF GOVERNMENT BOND STRATEGY, CRT CAPITAL, STAMFORD, CONNECTICUT
"There's not a lot of new information here. They certainly do acknowledge inflation has picked up but in same breath effectively say that 1) longer term expectations remain stable, and 2) that higher prices reflect crude and gasoline, and 3) that these will impact inflation 'only temporarily'. We see this as saying they are not worried, full stop, and are prepared to look past these pressures."

TOM PORCELLI, CHIEF U.S. ECONOMIST, RBC CAPITAL MARKETS, NEW YORK
"I would say it is probably a touch more dovish than the last statement. It does not seem to have much of a change from the last statement. Full focus is on the afternoon press conference and economic outlook."

While the volatility has indeed died down, bond prices are generally looking like they're under pressure at the moment. If we were clever, we might concoct some play on words to refer to this as "pressure before the presser," ('presser' being market/news slang for 'press conference'). But the pressure is nominal for now.

Volume is surprisingly light, further adding to the sense that markets are waiting for the remaining FOMC events this afternoon. The press conference happens at 2:15pm and the member forecasts slightly earlier at 2:00pm.

Until then, you're sort of in a predicament if you haven't locked yet but are thinking about it. Reason being: there's still no high-volume, runaway sell-off. Last FOMC, that was an easy call to make given the clearcut differences in the statements and the clearcut trading direction afterwards.

This time around we're getting more of an equivocal, grindy, sideways-to-perhaps-slightly-weaker trading pattern that just reeks of fear and anticipation. Anticipation is obvious, and the fear is that Bernanke doesn't say enough to keep the embers burning for QE3 fires and the like.

Because of that, we're in a situation where risks of reprices for the worse are unfortunately present, though can definitely be reversed in short order. Rock and a hard place. Some lenders might reprice, but the story is far from over for the day.

Volume and volatility are dying down somewhat now and bond markets live to fight another day (or another hour as the case may be, considering the upcoming Press conference and fed forecasts). Fannie 3.5's back to breakeven. Risks of negative reprices are greatly reduced.

Quick bounce off the lows puts Fannie 3.5's trading around 103-13. Looking like a bounce off 103-10. (failed breakout test).

103-10 has been broken in Fannie 3.5 MBS, increasing reprice risk for the worse. Currently 103-08.

The story is still unfolding... Yields spiked, MBS hit lows, Reprice risk is temporarily elevated, but we're not convinced of a major sell-off unless previous lows of the day (highs in terms of 10yr yields) break, and they haven't yet.

Treasury yields are well off their highs of the day following a strong 5yr Treasury Note Auction at 11:30pm. In additional tradeflows and positioning are helpful at the moment as the European session closes and removes some "risk on" demand that had contributed to early weakness. With the European session and the 5yr Auction out of the way, we're simply seeing markets adjust to where they want to be ahead of the FOMC events coming up in about half an hour. Viewed in this light, it seems to make a lot of sense for 10yr yields to be smack dab in the center of the 1.90 to 2.07 range.

Fannie 3.5's are up a tick at 103-17 and 10yr yields are still almost a bp higher on the day at 1.982. First line of support for MBS going forward is 103-13, with major support level number one at 103-10. That's a great line in the sand for shifting lock sentiment if we find ourselves falling after FOMC. The next, and even more epic line in the sand is around 103-00, but historically, bounces have occurred within a few ticks of that price itself (say 102-30 to 103-02).

A few notes about the upcoming 5yr Note Auction:

- Note that the auction happens at 11:30am, an earlier time than normal due to the afternoon's FOMC events.

- It's fair to expect that the response will be subdued to some extent because of those looming FOMC events.

- The recent average bid-to-cover ratio is 2.94

- 5yr yields awarded at auction have tended to be slightly lower than the 1pm "when-issued" yield

- current 5yr when-issued yields have been between 0.897 and 0.899