MBS MID-DAY: Draghi Fires Blanks, Bond Markets Rally

MBS Pricing Snapshot

- Factory Orders -0.5 pct vs +0.5 pct consensus
- Durable orders revised to +1.3 from +1.6
- Excluding transportation -1.8 pct, most since March 2009
- Reaction to this and other domestic economic data has been fairly limited so far this morning, as expected, in favor of the ongoing reaction to Draghi's ECB press conference.

New orders for manufactured goods in June, down three of the last four months, decreased $2.1 billion or 0.5 percent to $465.8 billion, the U.S. Census Bureau reported today. This followed a 0.5 percent May increase. Excluding transportation, new orders decreased 1.8 percent.

Shipments, down two of the last three months, decreased $5.3 billion or 1.1 percent to $469.9 billion. This followed a 0.3 percent May increase.

Unfilled orders, up following two consecutive monthly decreases, increased $3.4 billion or 0.3 percent to $988.1 billion. This followed a slight May decrease. The unfilled orders-to-shipments ratio was 6.27, up from 6.24 in May.

Inventories, also up following two consecutive monthly decreases, increased $0.4 billion or 0.1 percent to $605.4 billion. The inventories-to-shipments ratio was 1.29, up from 1.27 in May.

30-year fixed-rate mortgage (FRM) averaged 3.55 percent with an average 0.7 point for the week ending August 2, 2012, up from last week when it averaged 3.49 percent. Last year at this time, the 30-year FRM averaged 4.39 percent.

15-year FRM this week averaged 2.83 percent with an average 0.6 point, up from last week when it averaged 2.80 percent. A year ago at this time, the 15-year FRM averaged 3.54 percent.

5-year Treasury-indexed hybrid adjustable-rate mortgage (ARM) averaged 2.75 percent this week with an average 0.6 point, up from last week when it averaged 2.74 percent. A year ago, the 5-year ARM averaged 3.18 percent.

1-year Treasury-indexed ARM averaged 2.70 percent this week with an average 0.4 point, down from last week when it averaged 2.71 percent. At this time last year, the 1-year ARM averaged 3.02 percent.

After talking up the metaphorical monetary policy "gun" last week in a London speech, ECB Pres Mario Draghi pulled it out at today's post-ECB Announcement press conference. The following image captures the essence of that gun's firing power:

In the week ending July 28 the advance figure for seasonally adjusted initial claims was 365,000, an increase of 8,000 from the previous week's revised figure of 357,000. The 4-week moving average was 365,500, a decrease of 2,750 from the previous week's revised average of 368,250.

The advance seasonally adjusted insured unemployment rate was 2.6 percent for the week ending July 21, unchanged from the prior week's unrevised rate.

The advance number for seasonally adjusted insured unemployment during the week ending July 21 was 3,272,000, a decrease of 19,000 from the preceding week's revised level of 3,291,000. The 4-week moving average was 3,298,500, a decrease of 11,500 from the preceding week's revised average of 3,310,000.

You know the old cartoon schtick... The gun fires, but no bullets come out, and instead a very non-threatening and anticlimactic flag pops out and unfurls to reveal the text "bang!"

At this point, Draghi's speech and Q&A session have made even that comedic gun look like something serious. What we're actually hearing on the live feed right now is more of a joke than the prank gun ever was.

Essentially, the ECB did not announce that they would be buying bonds but said the MIGHT, but that the manner in which this would be accomplished has yet to be determined. Draghi was clear to pay respect to the fact that any such actions would have to fall within the ECB mandate and should be subject to "strict conditionality."

Reporters have been grilling Draghi on his remarks last week that seemed to promise swifter action, and he went so far as to note that he was "surprised by the attention given to the idea of an ESM banking license." Really Mario? Really?! He must not watch the same news we watch...

The bottom line is that the speech and the Q&A have been one colossal let-down after another for any market participants hoping for the ECB to inspire real confidence that they're equipped to materially improve the destinies (and funding costs) of the most at-risk European peripheral economies, namely Spain and Italy.

Domestic bond markets have catapulted back to previously stronger levels with 10yr yields down into the 1.47's and Fannie 3.0 MBS back over 104, up 9 ticks on the day to 104-02. Volume is the highest in two months and the trading reaction continues to unfold, but it's very much a "so far so good" for Treasuries and MBS and a very scary commentary on the Euro-zone's ability to take care of business.

The overnight session was largely uneventful and fairly light in volume with 10yr Treasuries holding a narrow range between 1.51 and 1.53. This sort of "calm before the storm" was evident across FX and Fixed-Income markets as the grand unveiling of whatever it is that the ECB will do to back up their tough talk was set for 7:45am or 8:30am depending on which bullets were to be fired.

With the 7:45am benchmark rate announcement out of the way, the remaining policy tools the ECB may employ would be announced at the 8:30am press conference. Bond markets have moved somewhat swiftly into moderately weaker territory as those "remaining policy tools" would likely be less friendly for rates in the US than a simple ECB rate cut would have been.

In other words, the fact that the ECB didn't simply cut their benchmark lending rate implies a greater likelihood that something more meaningful will be announced to help reign in rising borrowing costs in Spain and Italy. The more those costs are reigned in, the more the Euro zone is perceived as tiptoeing back from the brink--and this would pull money out of the safe-haven bid for Treasuries and other assets nearest to the risk-free end of the spectrum, like MBS.

10yr yields moved up from an overnight high of 1.53 to the mid 1.55's currently. Fannie 3.0's are currently 6 ticks lower at 103-19. The ECB news at 8:30am may take a few moments to sort of trickle in and be absorbed by markets, but don't confuse the movement with the Jobless Claims report coming out at the same time. Whatever movement we see is likely to be almost exclusively driven by the ECB.

European Central Bank President Mario Draghi was under intense pressure from investors, European leaders and even the United States to deliver on Thursday on his pledge to do whatever it takes to save the euro.

The central bank decided at its monthly policy meeting to keep interest rates on hold at 0.75 percent, but financial markets were waiting for Draghi's news conference (1230 GMT) to see what plans may be afoot to bring Italian and Spanish borrowing costs down to more affordable levels.

"This was not a surprise," Rabobank economist Elwin de Groot said of the rate decision. "It is much more important to see what other measures they might have decided."

Any sign that Draghi overplayed his hand when he made the bold pledge a week ago could see markets punish the euro zone.

His comments in London last Thursday that the ECB would do whatever it takes within its mandate to protect the currency bloc from collapse - "and believe me, it will be enough" - have already eased tensions on the debt markets.

Reuters reported on Monday the main idea under consideration by the ECB is re-activating its bond-buying programme for Spain and Italy in tandem with the euro zone's rescue funds, but that action could be at least five weeks away. (read more)

The ECB left their benchmark interest rate unchanged at 0.75 percent. Despite this being the the market's consensus, a benchmark rate cut was one of the bullets that the ECB may have fired today to back up Draghi's assertions that the central bank would be taking bold, sufficient action to shore up funding costs in Spain and Italy. This places the focus squarely on the 8:30am press conference as the venue at which additional bullets may or may not be fired.