MBS MORNING: Treasuries Better. MBS Follows the Leader
Good Morning All.
Yesterday the MBS market was dominated by sellers as buyers took a moment to reflect on the looming Treasury auctions ($65bn notes this week). MBS trading flows were light and volume below average while the yield curve continued to steepen into the 5 pm "going out" close. In the overnight session Treasuries rallied after overseas stock markets moved mostly lower. The 10 yr note yield fell 8 basis points to 3.84 after hitting an intraday high of 3.92 yesterday. A trading range between 3.78 and 3.92 has been established over the past two session.
Benchmark TSYs are rallying this morning and Mortgage-backeds continue to take their directional guidance from Treasuries...so we are seeing some green on the board this AM.
I am sure you are tired of hearing us say that MBS are taking their directional guidance from the yield curve...but it is what it is, so we must talk about what's moving money across the curve. Today's most notable event: the 3 yr note auction. This auction will create an opportunity for professional traders to position and reposition themselves around the expected gyrations of the yield curve....we'd expect to see fluctuations around the previously outlined range's median yield levels.
Another reason for a rally this morning (besides rallying Treasuries) is bargain buying after MBS sold off and yield spreads widened yesterday (relative value cheaper). Since most accounts were absent bid side supporters yesterday, we should see a few market participants doing some speculative spot buying today. Remember: wider yield spreads imply traders will prefer to buy MBS compared vs. TSYs...plus actual dollar prices are considerably cheaper than they have been over the past month.
As the market determines its own fate (up, down, sideways) professional traders will SELL INTO STRENGTH and BUY ON WEAKNESS. They will set multiple positions and look to beat their neighbor to profits....this implies you may see some seeminly irrational movements in price and yields...just as we have witnessed over the past two weeks. Overall big picture, the broad marketplace still awaits guidance. Here is the morning price behavior of the new (hopefully briefly held) "current coupon" title belt holder...the FN 5.0
Today is notification day for June Class A MBS settlement. Later this afternoon MBS prices will seemingly fall 10-12 ticks. Dont panic. Prices are not falling...the delivery date is moving forward one month, the "drop" in prices is a function of the time value of money and supply/demand in the marketplace. Here is a brief explanation:
The MBS coupons that determine your rate sheet pricing are traded in the TBA MBS market...TBA = To be Announced. In the TBA market, at the time of a trade, buyers and seller agree to only a few specific terms, like what coupon, the issuing agency (Fannie or Freddie), and a buy/sell price....the actual pools of loans that will be bought and sold are not disclosed at the time of this agreement. Instead, two days before the pre-scheduled settlement date (determined by SIFMA), the MBS seller "notifies" the MBS buyer of the specific pools that they will deliver to satisfy the previously agreed upon trade. The MBS buyer then reviews the pool information to ensure that the seller is delivering pools of loans that meet the agreed upon terms (which were determined at the time of the trade). Then two days later, on settlement date, funds are wired and the trade is complete (it goes deeper...this is the outline of the trading process).
The TBA trading mechanism plays a very important role in the generation of mortgage rates. The TBA market allows originators to make "forward commitments" before the loans in their pipeline are actually closed...just like loan officers lock in interest rates before the loan closes. For both the mortgage bank and the loan officer, this function serves as a hedge. It allows them to protect their pipelines from interest rate risk (rates getting higher and their loans not being worth as much). If mortgage bankers were forced to lock in their rates after closing...they would add in a large "interest rate risk" premium to protect themselves from shifts in the yield curve.
Again: the "roll" from this months delivery date to next month's will result in a 10-12 drop in MBS prices at close. Do not panic this is normal and is not usually accounted for in rate sheets. That said rate sheets are moderately improved this morning...but still in the mid-5s (unless you are privy cash window pricing)....but dont worry..talking heads are already stepping up the chitter chatter about higher interest rates and the effects on housing. Finally...