MBS MID-DAY: Dealing With Weakness Gracefully

MBS Pricing Snapshot

(Reuters) - Germany dismissed a French-led call for euro zone nations to issue common bonds, a day before a European Union leaders' summit which investors are looking to for new measures to counter the bloc's debt crisis.

After a torrid week, stock markets rallied on optimism that the Wednesday summit would produce measures to foster growth and ward off the threat of contagion should Greece exit the euro.

The FTSEurofirst 300 index of top European shares was up 1.2 percent by 1230 GMT and Spanish and Italian borrowing costs fell, leaving scope for disappointment if the EU leaders underwhelm.

French President Francois Hollande will push a proposal for metalizing European debt at the informal summit, a scheme which many economists and policymakers say could be one of the most effective ways of restoring market confidence.

Hollande has also called for a focus on growth rather than austerity.

But there is no sign that Germany, the EU's paymaster, is prepared to soften its opposition. It says more progress is needed first on coordinating fiscal policies, a stance in which it has the backing of the Netherlands, Finland and Austria among others.

"Tomorrow's meeting will not deliver any landmark solution. The market is likely to be more prone to disappointment," said Matteo Regesta, a strategist at BNP Paribas.

A senior German official said Berlin did not believe jointly issued euro zone bonds were the solution and would not change its view, at least in the near-term.

"That's a firm conviction which will not change in June," the official said at a German government briefing. A second summit will be held at the end of next month.

Treasuries have been on the run throughout the overnight session as Asian accounts were sellers from the outset. European markets only added to the relative dose of negativity as Italian and Spanish spreads narrowed ahead of tomorrow's EU Summit and pressure from corporate issuance weighed on Treasuries as well.

The more recent bones of contention for a continuing low-yield environment have been generally improving equities markets so far this morning and a slightly better than expected Existing Home Sales number just now. S&P's are up around 10 points from y'day and bond markets are struggling to hold support levels, particularly 1.80 in 10yr TSYs and 104-04 in Fannie 3.5 MBS.

There's no scheduled Fed buying to assist longer-maturity debt today, not to mention scheduled Fed selling in th 1-1.5yr range coupled with the need to take down this afternoon's 2yr TSY Auction. If bond markets continue to weaken, we're looking for the next supportive pivot at 1.817 followed by 1.86 in terms of 10yr yields.

Next major support for MBS is 103-31 in Fannie 3.5's, but with prices currently at 104-06, and 10yr yields currently at 1.799, we have yet to confirm breaks through existing support levels. Bottom line, we're definitely in weaker territory, but that territory remains in line with the long term trends for now. The scary thing about that from a rate sheet standpoint is that 10yr yields could move all the way up to around 1.87 and STILL remain in the long term positive trend.

Manufacturing activity in the central Atlantic region expanded in May for the sixth consecutive month but at a more moderate pace than a month ago, according to the Richmond Fed's latest survey. Looking at the main components of activity, shipments held steady and employment grew at a faster rate, while new orders grew at a rate well below April's pace. Most other indicators also suggested a slowdown in growth. District contacts reported that backlogs turned negative and capacity utilization grew more slowly. Vendor lead-time grew at a slower rate, while raw materials inventories grew at a quicker pace.

In spite of the recent moderation in activity, assessments for business activity over the next six months remained generally positive since our last report. Contacts at more firms anticipated that shipments, new orders, backlogs, capacity utilization, and capital expenditures would continue to grow at a solid pace.

Survey assessments of current prices revealed that both raw materials and finished goods prices grew at a somewhat slower rate in May than a month ago. Over the next six months, respondents expected growth in both raw materials and finished goods prices to rise at a somewhat slower pace than they had anticipated last month.

Existing-home sales rose in April and remain above a year ago, while home prices continued to rise, according to the National Association of Realtors®. The improvements in sales and prices were broad based across all regions.

Total existing-home sales1, which are completed transactions that include single-family homes, townhomes, condominiums and co-ops, increased 3.4 percent to a seasonally adjusted annual rate of 4.62 million in April from a downwardly revised 4.47 million in March, and are 10.0 percent higher than the 4.20 million-unit level in April 2011.

Lawrence Yun, NAR chief economist, said the housing recovery is underway. “It is no longer just the investors who are taking advantage of high affordability conditions. A return of normal home buying for occupancy is helping home sales across all price points, and now the recovery appears to be extending to home prices,” he said. “The general downtrend in both listed and shadow inventory has shifted from a buyers’ market to one that is much more balanced, but in some areas it has become a seller’s market.”

Total housing inventory at the end of April rose 9.5 percent to 2.54 million existing homes available for sale, a seasonal increase which represents a 6.6-month supply2 at the current sales pace, up from a 6.2-month supply in March. Listed inventory is 20.6 percent below a year ago when there was a 9.1-month supply; the record for unsold inventory was 4.04 million in July 2007.

“A diminishing share of foreclosed property sales is helping home values. Moreover, an acute shortage of inventory in certain markets is leading to multiple biddings and escalating price conditions,” Yun said. He notes some areas with tight supply include the Washington, D.C., area; Miami; Naples, Fla.; North Dakota; Phoenix; Orange County, Calif.; and Seattle. “We expect stronger price increases in most of these areas.”

(Reuters) - China can now bypass Wall Street when buying U.S. government debt and go straight to the U.S. Treasury, in what is the Treasury's first-ever direct relationship with a foreign government, according to documents viewed by Reuters. The relationship means the People's Bank of China buys U.S. debt using a different method than any other central bank in the world. The other central banks, including the Bank of Japan, which has a large appetite for Treasuries, place orders for U.S. debt with major Wall Street banks designated by the government as primary dealers. Those dealers then bid on their behalf at Treasury auctions.

China, which holds $1.17 trillion in U.S. Treasuries, still buys some Treasuries through primary dealers, but since June 2011, that route hasn't been necessary.

The documents viewed by Reuters show the U.S. Treasury Department has given the People's Bank of China a direct computer link to its auction system, which the Chinese first used to buy two-year notes in late June 2011.

China can now participate in auctions without placing bids through primary dealers. If it wants to sell, however, it still has to go through the market.

The change was not announced publicly or in any message to primary dealers.

"Direct bidding is open to a wide range of investors, but as a matter of general policy we do not comment on individual bidders," said Matt Anderson, a Treasury Department spokesman.