MBS Live Day Ahead: As Treasuries Consolidate, MBS Have Been Outperforming

One of the best side effects of the recent consolidation has been the outperformance of MBS vs Treasuries.  We often talk about the fact that MBS like stability and predictability.  Conversely, they tend to underperform when the broader bond market is making a big move into levels that haven't been seen in a while.

That last bit is an important point of distinction.  I'm NOT saying MBS don't like big moves--just the big moves away from the prevailing trading range.  The following chart shows all of this in action.  The candlesticks are 10yr Treasuries and the blue line is the spread between Treasury yields and MBS yields (higher = weaker MBS).  Notice that MBS were at their weakest versus Treasuries in mid-2016, and again in Nov 2018.  These happened to be the two most recent extremes in 10yr yields (all time lows and 7-yr highs).  

As Treasuries have backed away from those 7-year highs, MBS performance has recovered.  This is a very good sign in a world where the Fed is no longer reinvesting anything into the MBS market.  It means we've finally reached a point where there's enough demand for mortgage debt that the Fed doesn't have to continually serve as the biggest buyer.  

Why did that take so long?  Simply because the Fed was still reinvesting MBS proceeds back into new MBS purchases until October 2018.  Many in the secondary market were watching spreads to see if they would eclipse 2016's highs.  The nice "double top" is what's reassuring.

The immediately tangible implication for the industry is that rates are more than an eighth of a point lower compared to Treasuries.  While there's no compelling reason to expect spreads to thunder back down to late 2017 levels, the reinforcement of the ceiling is most important.  The more regularity lenders see in MBS valuations, the better equipped they are to pass along the gains on rate sheets.

As for today's specific events, the only bigger-ticket event will be the 10yr Treasury auction at 1pm.  This will be the lowest yielding auction in a year and thus another good test of bond trader sentiment with respect to the current range.