MBS RECAP: Disorderly Day For Bond Markets but Gains Intact

Right from the outset, seemingly strange things were happening as 10yr yields looked much higher on charts, yet were reported as being slightly lower than the previous session.  This can happen four times a year on the day after the quarterly refunding auction (which was yesterday).  This is basically like "the roll" for Treasuries and the newly created security is now the representative for 10yr yields. 

Much like MBS trade multiple delivery months at a time, Treasuries trade on a "when-issued" basis before an auction.  This means there are two yields in play: the cash yield that the world sees on the web and TV, and the when-issued yield that markets use to improve liquidity surrounding the auction process.  Much like MBS, securities that are "farther in the future" (like a June MBS coupon is farther in the future than a May MBS coupon) are slightly lower in price and higher in yield.  So despite the strong auction yesterday and lack of movement overnight, 10yr yields opened higher because they're now based on the newly created security from yesterday's auction.

Today's auction of 30yr Bonds was not nearly as well received and made for bond market weakness in the afternoon.  Fortunately, there was enough strength intact from the morning's central banker speeches (Yellen and Draghi) that we're now coasting out in relatively unchanged territory. 

You might not know it though, based on MBS charts.  The Fannie 4.0, particularly, looks like a volatile mess.  This has everything to do with the MBS Settlement process.  The most important thing to understand about volatility on the day that MBS roll to the next month's coupons is that there is hardly any trading still happening in the "front month" by mid-day. 

An absence of trading means that any bid/ask quotes entered into trading systems are going to have a huge, immediate effect on displayed pricing, even if they aren't indicative of trades actually being executed at those levels.  Complicating things even more was the fact that lower coupons outperformed in general as the rate rally increases appetites for 3.5s vs 4.0s.  Bottom line: Fannie 4.0s are showing -4/32nds at the moment, but based on all the relevant behind-the-scenes considerations, MBS are actually flat to slightly improved on the day.  Expect prices to open 8-12 ticks weaker tomorrow after the roll.