MBS RECAP: Energizer Bunny Rally for Mortgages

MBS Pricing Snapshot

After an early feint toward 101-03, Fannie 3.5's are back to their highs of the day. They just became NEW highs, actually, hitting 101-14 and climbing. This is more than a three quarter point improvement at the moment! All this despite the fact that 10's CONTINUE to hold above 2.47. That said, the bounce back that took them to mid 2.49's reversed course shortly thereafter and the steady descent back toward lower yields has been great for MBS's ongoing tightening campaign.

This is not a negative reprice alert! In fact, many lenders may still reprice positively, but we just wanted to give you a quick heads up that the slow, steady MBS rally looks like it's turning as 10's make a more convincing move higher off their 2.47 resistance.

10's now up to 2.494 and Fannie 3.5 MBS off their 101-13 highs to 101-08 at the moment. We'll put out another alert if things get worse, but if you already got the positive reprice you were hoping for, it's increasingly looking like now may be as good a time as any if you were going to lock today.

This is sort of fun to watch... Nothing new compared to previous observations, really--just more of the same "MBS improving while Treasuries hold steady." It's fun because the roles were so painfully reversed until this week, but ever since washing out to their worst levels of underperformance on Monday Morning, MBS have steadily been turning the screws, clamping down yields vs Treasuries. These moments where Treasuries are stuck going sideways make it the most noticeable.

Pleasantly, the "stuck sideways" for Treasuries continues to be at their lows of the day at 2.47 (currently 2.474). MBS have now ratcheted up to their highs of the day with Fannie 3.5s up 21 ticks at 101-12. If 10's manage to break below 2.47, we could see some follow through from technical stops being hit, or it could be a cue for profit taking. The longer it's held or improved upon, MBS should continue to incrementally benefit.

7yr Auction strong. First move is down. Not sure if there will be any knee-jerk bounce yet, but 10's just moved to test 2.475. Didn't break, so no runaway rally, but in the spectrum of better vs worse, the reaction so far is better. Stay tuned for more...

2.51-2.52% has turned out to be an important short term inflection point for 10yr yields. Along with 2.47%, it forms a 4-5bp band of yields that has acted as an inflection point for the shift from the 2.4's to 2.5's seen after last week's FOMC events. In other words, this is like the gateway between the two broader zones (2.4's and 2.5's), and when yields have entered it, they've been more likely to bounce vs break. In fact, yields have only moved through this zone one time since mid 2011, just last week, and have yet to break back below 2.47

So it was of some concern that 10's had been moving rather quickly higher after bouncing at 2.47 following this morning's strong Home Sales data, briefly cresting 2.52 just before our last alert. They subsequently moved back lower into the "zone" discussed above and are holding there ahead of the 7yr Auction.

It's not too late for Treasuries in general, to make a concessionary move higher in yield ahead of the auction, but the simple fact that they HAVEN'T YET, has been enough for MBS to hold near their highs of the day and pull up from the 6 ticks of weakness we saw heading into 11am. As such, this update effectively takes the reprice risk outlook back to neutral, but we'd stay on guard over the next 45 minutes for any potential pre-auction weakness.

Keep in mind that post auction weakness isn't out of the question either. 7yr Notes don't tend to move markets as much as other issuances, but market participants may have been expecting some sort of "post-supply relief" to such a unified extent that some of that relief rally may even be built in to pre-auction trading. To simplify that concept, the last few weeks have been rough. Traders have to buy Treasuries at auction and may have been apprehensive about trading levels given the volatility. Some of the recent weakness is therefor assumed to be "extra room" to provide comfortable entry points for the investors forced to accumulate new inventory. The low 'bid-to-cover' ratios speak to this phenomenon.

It is consequently assumed that this defensiveness can relax a bit after the auctions are over (which is today), but what we're saying is that this assumption is so obvious that it may actually be having a net positive impact on trading levels ahead of the auction, thus requiring genuinely strong auction results in order for the rally to extend beyond the 2.47 resistance that currently blocks 10yr yields.

It's been a slow-motion reaction to the extra-large 'beat' in Pending Home Sales, but we may be confirming a bounce at the highs. Offsetting the much better-than-expected home sales data has been another dose of Fed speakers jumping in to moderate the market's tapering expectations.

Dudley was first up in this regard, with his prepared remarks hitting at the same time as Pending Home Sales (likely softening the otherwise more bond-bearish blow). In other words, Dudley's reminder that the Fed's withdrawal of QE3 depending on economic conditions and not on calendar dates, as well as his assertion that the Fed would keep most assets on balance sheet for a long time (meaning more accommodation for mortgage markets) was a positive factor for bond prices versus Pending Home Sales being a negative factor.

Fed's Powell was just out in a similar vein, but was less obviously trying to talk markets off the ledge. He even went so far as to argue the other side of the "soothing agenda" by saying that tapering and withdrawal could happen EVEN SOONER if economic conditions warrant. Granted, he was likely trying to emphasize the same point about the decision being "all about economic data," but in so doing, made another statement that stood the risk of spooking bond markets.

Dudley, in his Q&A, which is ongoing, subsequently reiterated the same notion, saying that economic data is MORE IMPORTANT than the risk that tighter financial markets may hurt the economic recovery. In other words--and this is an important point--THE FED IS NOT IN THE BUSINESS OF TRYING TO PREDICT HOW THEIR POLICY CHANGES WILL AFFECT THE RECOVERY! Data first, policy reaction second!

Bond market bulls would hope for something else--perhaps for the Fed to be concerned enough about the recent rise in rates to "do something" about it in the next few months, but Dudley is reaffirming that which we've already harped on. Again, that's "data first, reaction second."

The extent to which that is playing in to the incremental weakness we've seen since 10am is unclear, but there's no need to overcomplicate things. Bond markets hit their best recent levels and then got a healthy dose of bullish economic data. They've since turned a corner and are heading in the other direction. Rate sheets generally came out before that corner was turned, so some negative reprice risk is a factor soon-ish. Fannie 3.5s are off their 101-04 highs, down 6 ticks to 100-30.