MBS RECAP: Weaker Into The Close Despite Killer Auction. Just A Head Fake?

MBS Pricing Snapshot

As frustrating as it is to see America's sweetheart--Fannie 3.0 MBS-- having a hard time at the moment, it's happening. Sellers are looking to sell, and buyers are out for the day. Things are leaking lower into the afternoon. 10yr yields approaching the highs of the day and a late day mini-recovery for stocks isn't helping. We'd probably ramp up negative reprice risk at these levels, but would still say that not every lender is going to get involved with that at current levels (and probably not even a majority of lenders unless things weaken further).

Choppiness after 3pm is due to positional adjustments after the Treasury close. Nothing going on at the fundamental level.

Essentially, we got a boost from the auction and it was cancelled out by FOMC minutes that didn't do much to convince bond markets that they would be getting a big check any time soon. The post-auction rally was somewhat unsatisfying as it didn't have a chance to run very far given that markets rallied all week into 1pm today and are in all time low-yield territory. In that sense, holding sideways is a sort of rally.

Any aspirations of moving lower in yield were soon curbed by the upcoming FOMC minutes and it turned out to be a good thing as both sides of the market generally deflated on the lackluster notes from the Fed. So between the minutes and the auction, we're coasting along truing to hold the same old range we were trying to hold this morning. Pretty uneventful.

As far as reprice risk, we're still feeling like it's more of an issue at 103-15 or under in Fannie 3.0s. Pricing is pretty aggressive today though, so be on guard against any further deterioration here. An early cue might come from a break above 1.51% in 10yr yields. They're currently at 1.5065.

We're running out of allusions to The Natural in covering some of the more triumphant 10yr auctions over the past 11 months, but this one is right up there with August 2011. It would be just as easy to switch to Hulk references anyway, simply saying "10's...Smash!!!"

Indeed, 10's smashed through the 1pm when-issued yield with nothing short of brutality. Rarely do we see a 10yr auction stop through by more than 4bps, but at 1.459 vs a 1.501 1pm WI yield, today was 4.2 bps, just shy of the 4.3 from August, 2011. Most recent stop throughs have range from 0.4 bps to 1.2 for an average of .55 over the last 8 auctions.

The bid-to-cover ratio was evern more impressive though. 3.61 vs an 8 auction average of 3.1. A cursory glance tells us that only April 2010 had higher demand.

Following the auction, 10's immediately moved down to 1.465 and bounce hard there on profit taking and tactical shorts ahead of the 2pm FOMC minutes. Don't let the knee jerk fool you ! This is merely the "trader's sandbox" in action. The lines are no longer moving based on the auction. If it were up to the auction yields would be in the mid 1.4's or lower. What we're seeing now is a set up for the FOMC minutes.

If yields were to meaningfully break above today's highs around 1.533, then there might be more cause for concern, but failing that, we'll simply have to wait until after the FOMC minutes to see where markets really want to be. For now, somewhere slightly better than before the auction, but not quite as bullish as we'd like, is the most nimble perch from which to await the arrival of the minutes.

Because of all that "knee jerk" stuff, as well as the overall narrow range in MBS ahead of the knee jerk, positive reprices are not exceedingly likely until/unless MBS stay in the green or are improving after the FOMC minutes.

Fannie 3.0s are currently at 103-20, which was their high of the day before the auction.

MBS and Treasuries have held impressively narrow and resilient ranges ahead of the 10yr auction at 1pm, with no major concession despite markets' expectations.

After the 12:45 AM Fed auction bidding, WI yields (when-issued) for 10's are falling just under a bp and MBS are adding on a few ticks, essentially reinforcing the morning's range-trade.

As for the auction itself, today's is a reopening of the 1.75 coupon from the 5/9/12 refunding. Reopenings have recently garnered slightly better bid-to-cover ratios than refundings with a 3.17 average. The two bid-to-covers for this cycle have been 2.90 and 3.06, with the previous cycle bringing 3.05 on the refunding and 3.24 and 3.08 on the reopenings.

10's in general have had a tendency to "stop through" at lower yields than the 1pm WI. The "when-issued" yield (essentially the consensus estimate of where the auction will stop) is currently at 1.503, and we'll take an official mark at 1pm to compare to the auction results that follow about a minute and a half later.

By far the biggest surge in volume of the day was seen just after 11am. Two things occurred at that time: the conclusion of a round of scheduled Fed buying in the 2018-2019 range (6-7 yr) and the EU bond market close.

At first blush, both of those factors appeared to be net negatives for bond markets and both MBS production coupons were briefly in the red. 10yr yields rose by about 1bp in fairly short order as well.

The Fed buying results indicated that dealers offered up a lot of paper compared to what the Fed could buy (15.42 bln vs 4.77 bln purchased). This could tacitly suggest higher supply, lower prices, and higher yields, especially considering the expectation that bond markets will have to endure some weakness ahead of today's auction.

As for the EU Bond Market close, the implication there is that Treasuries had benefited to a certain degree from the low yields in German Bunds creating spillover buying, and would now potentially get less benefit after 11am with a less active Bund market.

Indeed it looked as if some sort of reversal could be taking hold, and we'd set out to alert you to that potential. But even as we started writing, the long end of the yield curve began firming up (i.e. 10's and 30's outperforming 7's and 5's). Additionally, Fannie 3.0's have outperformed 3.5's since 11am. This makes sense given that lower coupons have longer duration and longer duration debt is outperforming.

All told, we're left in fairly neutral territory after these post-11am gyrations, but on the low side of the recent range. While that range is narrow (103-16 to 103-20 in Fannie 3.0's), we'd stay on guard for a more meaningful concession ahead of the 10yr auction and FOMC minutes. 1.508 and 1.5133 would be the "bad" and "worse" technical levels to cross in terms of 10yr yields that would likely have a negative implication for MBS. Negative reprice risk increases around 103-15, and gets incrementally larger with each tick down.