MBS RECAP: Fed Flips One Script, Sticks to the Other; Facemelter Ensues

MBS Pricing Snapshot

Simply put, bond markets are at their best levels of the day. From the moment the FOMC Statement was out, markets realized the Fed is completely aware of what's at stake with an overly quick rush to taper. We couldn't be completely convinced this wasn't the case until today.

While it doesn't mean we won't gradually continue moving higher in rate longer term (though that depends on data, shockingly enough), it does mean we're likely to get that correction we've been hoping for.
br/> The first phase of that correction is clearly underway with Fannie 4.0s up 36 ticks (1-04 or 1.125 points) to 104-01+. 10's are down 16bps to 2.6823, and all of it has happened in a very linear fashion for a big move post-FOMC.

- What had just been "labor market indicators" has been contracted to "some indicators of labor market conditions." Subtle, but bearish.

- Mortgage rates have risen "further" now as opposed to "somewhat." Fed continues to be conscious of mortgage market in the statement itself.

- Previously, Fed said "downside risks" had diminished. This time, they added "but tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market."

- Fed throws down gauntlet to Congress/President in adding a new section to the announcement saying: "taking into account the extent of federal fiscal retrenchment," things have been going pretty well, but not well enough to taper yet. The Fed decided to "await more evidence progress will be sustained before adjusting asset purchases."

- Instead of saying their "prepared to increase or reduce the pace of purchases,' they've change this to say "In judging when to moderate the pace," they'll assess whether the econ data supports the expectation of improvement. This is key. They're not only looking to hold steady, but to support improving expectations. This is different than some takeaways from previous Fed communications where Bernanke (in press conferences) has indicated that gains have been made and the Fed was just waiting to make sure they were sustainable.

- The Fed has now added a specific assertion: "Asset purchases are not on a preset course." They added that committee decisions will remain contingent on the data, but also has to keep an eye on efficacy and costs (which implicitly include risks of market disruption).

All told, this is incredibly bullish inasmuch as it's a refreshing revelation that the Fed isn't turning a blind eye to the economic fallout from higher rates. The Fed got a trial balloon up for the impact of tapering. They saw that it was too much, too soon (lessons from 1994 and 1998) and are CLEARLY acting to moderate the pace of the longer term sell-off that will ultimately continue if economic data stays on track of tepid improvement.

MBS and Treasuries are about a point better in price. 10's are down to 2.72 and Fannie 4.0s are up to 103-27. Numerous positive reprices.

More to follow...

MBS are well into positive territory now with Fannie 4.0s up 3 ticks at 102-31+. 10yr yields just broke into positive territory at 2.8478. There's not much behind this outside illiquid pre-FOMC trading. Quite literally, "all bets are off" until the FOMC news hits.

That doesn't mean there won't be any activity between now and then, but what you see is not necessarily indicative of any heartfelt momentum. Any real trading here is last-minute position squaring, and bond markets are back in line with yesterday's range.

Lenders will be hesitant to reprice positively this close to the FOMC events, but it's not out of the question for some. Many lenders will simply be shutting down lock desks around 2pm until volatility dies down.

It's a wonder that any market participant still pays any attention to the barrage of threats and political posturing that precedes the final course of action on topics like the debt ceiling. While it does seem that we've increasingly learned our lessons from the last two go-rounds, today's Cantor/Boehner headlines couldn't help but have some effect. The odds-on favorite was when the Speaker said this year will be "no different" from the 2011 attempt to link the debt ceiling hike to budget cuts.

MBS and Treasuries sold off quickly, but not excessively and are now bouncing back moderately. Any negative reprice risk that had been growing before, is now mostly--if not completely--off the table.