The Day Ahead: Slightly Less Subdued; Gloomier Outlook Thanks to LLPAs

Yesterday

- Lack of participation on all fronts, low volume, low liquidity

- The made for a volatile morning, but within a reasonable range

- MBS were stronger in the morning thanks to tradeflows (data didn't matter)

- Weaker into the afternoon, but only a few reprices

- Fannie and Freddie released upcoming LLPA grids, giving rate-watchers something to think about

Today

- Treasury Auction cycle begins at 1pm.  May be more noticeable than most 2yr Auctions

- Morning data is fairly unimportant.  CPI is a non-issue and NAHB would have to miss/beat big

- Even then, Monday's data was far from consensus and markets didn't react accordingly, so...

- Waiting on Wednesday's FOMC

Strategy

The Week Ahead spells out the theme of the week and recaps the market exhaustion leading up to it.  Those themes remain in force until tomorrow's FOMC Announcement, and they were certainly evident yesterday.  MBS didn't even show up to trade until well into the 9am hour.  Even then, not in large numbers.  It ended up being the lightest day of the month and MBS hit 5pm at the exact same levels as the previous session, despite some morning volatility.

There's no reason to expect a big move in either direction today either.  While it's not uncommon to see bond markets "lead off" in one direction or the other ahead of major event, that's more commonly seen before Nonfarm Payrolls.  Additionally, FOMC is an afternoon event, leaving Wednesday morning as a venue for a potential lead-off.

Today brings roughly the same amount of data as yesterday and adds the first Treasury auction of the week.  With volume as low as it is, we would normally expect a slightly more pronounced reaction to the auction, but today's 2yr Notes have the lowest overall potential to move production MBS of any auction.  The morning's economic data includes the Consumer Price Index (CPI) at 8:30am and the NAHB Housing Market Index at 10am. 

It's easy, and likely appropriate to be cynical about both of these reports.  Low CPI doesn't make the Fed any less likely to taper tomorrow and high CPI doesn't increase the odds--not from these levels.  The inflation story is dormant.  NAHB is NAHB.  It's been a bit excitable in 2013.  If it's strong, markets will dismiss it as overly optimistic.  If it's weak, markets will merely see it as falling in line with the other generally cooler housing data.

On a final, more contemplative note. Fannie and Freddie released their LLPA grids in response to the FHFA directive to raise G-Fees in spring 2014.  The 10bps hike in rates is already understood, but this is the first look we've gotten at the other component of the G-Fee (LLPAs = Up-Front G-Fee).  The FHFA said that the grid would be reworked to better align costs with risk.  Apparently those with 680-760 credit scores and 80-95% LTVs had been severely underpaying (that's the implication anyway) as everything in that zone took at least a 0.75 point hit to upfront fee for the the 46 states+DC not left paying AMDCs and at least a 1 point hit for the AMDC states CT, FL, NJ and NY.  720-739 scores with 85-95 LTVs got hit the hardest--1.25 and 1.5 points for non-AMDC/AMDC respectively. 

Depending on lenders' implementation preferences and lock time frame, these fee changes will begin hitting fairly soon into 2014.  The combination of the G-fee hike and LLPA change look like at least a 0.25%-0.375% hit to rate for many borrowers.  Keep in mind that some lenders priced in the last G-Fee hike literally overnight.  That's sort of alike a "whammy" that may or may not be a consideration in in the near future, dissuading borrowers and originators from pressing their luck very much past January (April MBS pools and whole loan purchases take the hit, and these would being trading in greater numbers in February).

Charts

Instead of a chart, here's a table of the upcoming LLPA changes.  This grid represents the total change in LLPAs minus the .25 AMDC that most states will no longer be paying (so CT, FL, NJ, NY add 0.25 to the cost).