MBS MID-DAY: Heavy Losses Overnight; Mostly Recovered Now

MBS Pricing Snapshot

Although both MBS and Treasuries are still in negative territory on the day, a majority of the earlier weakness has been erased--at least for now. From lows of 102-27, Fannie 3.5s are back up to 103-05--a mere eighth of a point weaker on the day. 10's are down to 2.22after hitting 2.291 overnight.

The timing of the biggest move overnight clearly suggests the ECB / German Constitutional Court as a factor today. Whereas the overnight move was a knock against the ECB's ability to support markets, recent headlines from the debate go some small way toward moderating the previous one-sidedness. More simply, the court wants to limit ECB bond-buying, and now the ECB is making a case for it to be unlimited. Bond markets suffered on the news earlier and have benefited from the recent shift in tone.

Additionally beneficial is the Fed's scheduled buying in the 25-30yr space. There was reason to believe the last big push to the highest yields this morning was to help set up for this buyback. Now the question becomes: will the momentum carry through the 11:03am results? Or will excess inventory suggest short term resistance for falling yields.

Several lenders who priced early stand a chance to reprice positively at currently levels, but we would note that reprice activity tends to be relatively more subdued on MBS roll days.

- Inventories +0.2 vs +0.2 forecast
- Sales +0.5 vs +0.0 forecast

- Market reaction: not readily discernible from movement and volume, but there's an outside chance that this caused a minor "risk-on" move, adding maybe 1bp to tsy yields and a point to S&Ps. That's close enough to 'no reaction' to be considered as such.

The U.S. Census Bureau announced today that April 2013 sales of merchant wholesalers, except manufacturers’ sales branches and offices, after adjustment for seasonal variations and trading-day differences but not for price changes, were $416.6 billion, up 0.5 percent (+/-0.5%)* from the revised March level and were up 0.7 percent (+/-3.2%)* from the April 2012 level. The March preliminary estimate was revised downward $0.7 billion or 0.2 percent. April sales of durable goods were up 1.6 percent (+/-1.1%) from last month and were up 4.2 percent (+/-4.0%) from a year ago. Sales of furniture and home furnishings were up 5.1 percent from last month and sales of machinery, equipment, and supplies were up 5.0 percent. Sales of nondurable goods were down 0.5 percent (+/-0.4%) from March and were down 2.2 percent (+/-3.9%)* from last April. Sales of apparel, piece goods, and notions were down 6.0 percent from last month and sales of petroleum and petroleum products were down 2.7 percent.

Total inventories of merchant wholesalers, except manufacturers’ sales branches and offices, after adjustment for seasonal variations but not for price changes, were $504.8 billion at the end of April, up 0.2 percent (+/-0.2%)* from the revised March level and were up 4.1 percent (+/- 4.7%)* from the April 2012 level. The March preliminary estimate was revised downward $0.4 billion or 0.1 percent. April inventories of durable goods were up 0.2 percent (+/-0.4%)* from last month and were up 5.9 percent (+/-5.6%) from a year ago. Inventories of motor vehicle and motor vehicle parts and supplies were up 1.9 percent from last month, while inventories of metals and minerals, except petroleum were down 1.1 percent. Inventories of nondurable goods were up 0.1 percent (+/-0.4%)* from March and were up 1.4 percent (+/-5.8%)* from last April. Inventories of beer, wine, and distilled alcoholic beverages were up 2.3 percent from last month.

Treasuries faced a double whammy overnight as both Asian and European sessions provided reasons to sell. The first key event was the decision by the bank of Japan to forgo any further stabilization measures and to leave monetary policy unchanged. 10yr Treasuries actually weathered that initial storm fairly well, though it did account for yields remaining relatively higher than they otherwise would be considering recent correlation with Japanese markets (in other words, a strengthening of the Yen and tanking of the Nikkei has had a more salubrious effect in general than it did last night.

This bigger factor overnight was Europe. In fact, compared to the onset of German Bund trading, Japanese market movement looks downright flat. Bunds opened up and took Treasuries on a fantastic voyage (fantastically awful). The initial catalyst here was a comment from German Constitutional Court President Vosskuhle (who incidentally is one of the biggest market movers you've never heard of owing to the court's role in approving the constitutionality of ECB bond-buying programs... Who knew?!) who said that the extent to which the ECB's programs are successful has nothing to do with whether or not they're constitutional. In other words, central bank market-soothing and liquidity could be stifled on a matter of German principal.

Bunds were on the ropes from that point on and pulled US Treasuries with them. Futures volumes were bug though 2.264 managed to hold AT FIRST. Domestic traders took the sell-off to weaker levels (trend is your friend). Hopefully the logic at play here is that bond markets were reaching for the best supportive ceiling available (to cover shorts / reload longs / pick up some supply to sell back to Fed later this morning).

If that's the case, it's going well so far with 10's back down to 2.244 from 2.291 overnight. MBS, for their part, went a little bit crazy at the open, experiencing a relatively higher degree of price volatility in the first few minutes than Treasuries, but are mostly back in line with broader bond markets now (keep in mind that 4.0s are almost an equal partner to 3.5s at these levels). To that end Fannie 3.5 have been holding near 102-30 so far and Fannie 4.0s have been doing the same just over 105-03.

MBS performance vs Treasuries is within it's right to disconnect today as tonight's Class A Roll (Fannie/Freddie 30yr Fixed Settlement; today's the last day of trading for June coupons) leaves less room for flexibility in prices of June coupons.