MBS CLOSE: What Dreams May Come?
The positivity discussed in the last post stuck around through the "going out" close at 5pm with 4.5's and 5.0's gaining 6 and 5 ticks respectively. For MBS, this was not only the highest point of the day, but within a few ticks of yesterday's high. Tsy's also ended at the lowest yields of the day with the 10yr at 3.54, but in that arena, yesterday's lows at 3.47 were unattainable.
Things were fairly quiet as participants wait for the only substantial data points before next week. Volume was only about 3/4 of the 30 day average. We've discussed in the past how volatility takes a toll on rate-sheet-influencial MBS as uncertainty leads accounts away from duration. Volatility tends to rise into month end and NFP with a traditional levelling and sometimes abatement after NFP. Because of that phenomenon, NFP passing is one of the factors in the traditionally supportive week for MBS. Keep in mind, that this "support" is from the trader's perspective, and so places more weight on the potential benefits for the spread situation. As far as prices, which is what we care about more, we will continue to take cues from tsy's while fluctuating inside the recent spread trading range.
In general, whatever is bad for equities is good for us on NFP day. One of the reasons we keep harping on "DEFENSE!" is the fact that we've strung together a fairly solid winning streak over the past week and all good things must come to an end. The next probable day for MBS price positivity comes on Wednesday when accounts receiving pass-through MBS will get their monthly raft of payments which are sometimes reinvested into MBS to the point that prices benefit. It's not a given, but another factor in the positivity. That creates a window of 3-4 days where recent gains could retrace a bit and the price levels currently seen as a bit rich could correct before further gains into the end of the supportive week. From a "scheduling" standpoint, it makes sense, and is something to fear.
Also to be feared is the degree to which the broader markets would welcome another big sign of the recovery gaining momentum. Just as we are waiting for guidance, so are stocks. So is everyone. Will it be another leg down in the recession or will the dream stay alive (not my dream I can tell you!). Anything in the 300k's, even if worse than expected, is likely to be seen as confirmation that the recovery is real. The higher in the 300k range, the more pause might be given. The problem is that with the -365k consensus, basically anything under 400k is likely NOT going to be good for MBS and tsy's. In other words, a larger amount of the range of potential outcomes stands to be perceived as positive. We have to get back into the 400k's for a Friday rally. Even then, the headline payroll reading is not the only component.
The actual unemployment rate, which came in last month at 9.4% seems to matter more and more to investors the closer it gets to 10%. Tomorrow's consensus is for 9.6%. The last two months, however, it's packed on at least .4% from the previous reading. So tomorrow's consensus would be a drastic slowing to that trend. Wouldn't be good for MBS if that pans out as that could be a positive point investors latch onto even in the face of an uglier headline NFP. Hitting 9.8% or higher would be good. I think if we by some chance crack 10% (which I don't think the powers that be would allow to be printed just yet), that could work in our favor even if the headline is in the 300's. But doesn't all of this seem a bit frustrating? Just a few months ago an NFP print in the 300's would have sounded farcical. What has the world come to?! Your hope and mine is "hopefully not another brick in the wall of full-fledged recovery." If tomorrow's NFP creates that sentiment, the current relatively low benchmark and MBS rates will likely seem very scary to Joe Q Investor. Massive selling could ensue.
There are mitigating factors to be sure. One of the best bets for tomorrow is the often overlooked "average work week" component of the report. This is simple math really... The lower the hrs in the average work week, the less money consumers are getting to pay their bills and spend money. So even if the amount of people losing their jobs is slowing at the expected pace, a surprise decrease in average work week SHOULD lead investors--even if it takes them a few minutes or even hours to figure it out--to conclude things aren't as rosey as the headline reading. Here's hoping for logic to prevail should this component indeed pare a tenth or two... it's forecast to be in line with the previous reading of 33.1 hrs. 33.0 hrs or less could help offset damange caused elsewhere in the report.
As far as what this means to your pipeline, hopefully decisions have been made already. If you're past lock cut off for today, then there's not much else for tonight. If you're not however, consider those same types of deals you wish you'd locked before the last sudden and massive selling spree. I guarantee you if this market gets convincing enough guidance that all the promises of recovery are indeed being kept, the selling that follows could be ugly. AGAIN! We're not saying we expect this to happen, but rather, ANYTHING COULD HAPPEN, and to whatever extent tomorrow might be good, or sideways, it could also be really really bad. NFP is the kind of report that can precipitate record moves if the right mix of data hits a market anxious for direction. Normally however, that anxiety, if met with a mostly "as-expected" reading, serves to create a lot of volatility tomorrow that may even end up unchanged.
The bottom line is--unlike the low points in mid-June--there is no clear upside or downside in our near future. The 10yr is trading right around most economists' year end consensus and MBS are right in the low range of 2009's dream-like positivity. If the economy's "bad dream" is shown to have some life yet tomorrow, our "good dream" might be rekindled. If, on the other hand, the message is that "the nightmare is over," it may well be time for MBS to wake up to a reality that's not quite as perfect as the one to which we grew accustomed through May. Or all this could be for naught and we could simply continue sleeping, waiting for something--either good or bad--to relieve the suspense. Sweet Dreams...
2s vs.10s: 249bps
6/30 EFFECTIVE FED FUNDS: +0.05 to 0.17 from 0.22
LIBOR FIXINGS
O/N LIBOR: -0.0100 to 0.2675 from 0.2775
1 MONTH: -0.0025 to 0.3063 from 0.3088
3 MONTH: -0.0075 to 0.5875 from 0.5950
6 MONTH: -0.0200 to 1.0912 from 1.1113
1 YEAR: -0.0163 to 1.5900 from 1.6063