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MBS OPEN: Perspective on Bond Market Weakness. Reaction to Politics
January 28th, 2010 1:52 PM

MBS OPEN: Perspective on Bond Market Weakness. Reaction to Politics


All was good  in the rates  market leading up to 215pm yesterday.

Rate sheet rebate was holding close to month over month bests, 10s were quietly bouncing back and forth around 3.62% and the FN 4.5 MBS coupon continued to move in a range. This was all occurring in slow/thin trading conditions as market participants were reluctant to venture too far from recent pivot points ahead of major market moving news.

Then came the FOMC statement at 2:15pm.

While the text and language of the release held few surprise, there were hints of continued positive stabilization progress, for example, instead of saying "economic activity has continued to PICK UP", the Fed communicated that "economic activity continued to STRENGTHEN". The Fed also made it clear that they intend to carry out plans to exit from several quantitative easing liquidity programs: the ABCPMMMFLF (hahah what? the asset backed commercial paper money market mutual fund liquidity facility), the CPFF, the PDCF, TSLF, aaaand the MBS purchase program. This clears the way for the Fed to start studying the potential for further withdrawals from financial markets when the market is ready.

That was the good part...now for what I consider to be the BAD, or at least the ODD part.

I found it interesting that the FED updated the statement's language regarding housing. Perhaps instead of saying "updated" I should say REMOVED. In December the FOMC stated that housing had "shown some signs of improvement", in the January text  there was NOTHING ABOUT HOUSING.  I find it very odd that they didnt at least leave the verbiage as it was...removing it raises a HUGE RED FLAG to me. Actually, my RED FLAG has been waving for months so I suppose this could be a sign that the Fed may be starting to see that the real estate market is still in big trouble.  Housing is clearly a huge variable in the Fed's outlook...

Here is a recap of the rest of the statement:

  • FED REAFFIRMS PROMISE TO KEEP RATES EXCEPTIONALLY LOW FOR AN EXTENDED PERIOD
  • FED REPEATS EXPECTATION THAT MORTGAGE BACKED SECURITIES, AGENCY DEBT PURCHASES TO BE EXECUTED BY END OF Q1
  • SWAP ARRANGEMENTS WITH CENTRAL BANK COUNTERPARTIES WILL CLOSE SWAP ARRANGEMENTS ON FEB 1
  • FED SAYS WINDING DOWN TERM AUCTION FACILITY, FINAL AUCTION TO BE ON MARCH 8
  • HOENIG ONLY DISSENT IN DECISION ON POLICY ACTION; BELIEVED CONDITIONS CHANGED, LOW RATE, EXTENDED PERIOD VOW NO LONGER NEEDED
  • ECONOMIC ACTIVITY TO STRENGTHEN, DETERIORATION IN LABOR MARKET ABATING
  • HOUSEHOLD SPENDING EXPANDING AT MODERATE RATE, CONSTRAINED BY WEAK LABOR MARKET, TIGHT CREDIT
  • INVESTMENT IN STRUCTURES STILL CONTRACTING, BUSINESSES RELUCTANT TO ADD TO PAYROLLS
  • BANK LENDING CONTINUES TO CONTRACT, BUT FINANCIAL CONDITIONS SUPPORTIVE OF GROWTH
  • PACE OF RECOVERY SEEN MODERATE FOR A TIME, FED ANTICIPATES GRADUAL RETURN TO HIGHER RESOURCE USE
  • FED SAYS WITH HIGH UNEMPLOYMENT, STABLE INFLATION EXPECTATIONS, INFLATION LIKELY SUBDUED FOR SOME TIME

I think it was a function of a few reasons. The general "CONTINUED STABILIZATION" tone was obvious. The Fed is starting to set themselves up for an eventual exit from the marketplace. This implies economic conditions are getting closer to warranting a more serious RATE HIKE discussion. (Dont read this the wrong way....it only means the Fed is feeling more confident that a double dip will be avoided, it does not mean recovery). This gives equity siders some hope of consumer demand improvements to come. The other reason was the 9-1 vote. Hoenig dissented! The short end of the yield DID NOT LIKE THIS....which forced rates higher in the "Rate sheet influential" long end of the yield curve. (BEAR FLATTENER).

While HOENIG is not completely to blame for this move, because the yield curve was already flattening ahead of the FOMC statement, his dissent did not help. The most aggressive selling yesterday was in 2s and 5s (hmmm we just took down $86 billion in 2s and 5s right?). This implies fcurve flattening may have been a function of dealers distributing debt supply to their accounts. Following the release of the FOMC Statement the curve did further flatten as 2s and 5s sold off, so I do concede that the bond market did have a negative reaction to the 9-1 vote as a rate hike may come sooner than expected.

Plain and Simple: the "rate sheet influential" end of the yield curve appears to be a victim of circumstances yesterday. SUPPLY DISTRIBUTION and a "CONTINUED STABILIZATION" tone from the Fed. Check out the chart below...the flattener was already in motion ahead of the FOMC.

I want to go back to housing real quick just so my point is made clear: WITHOUT JOB CREATION THE HOUSING RECOVERY WILL BE A SLOW PROCESS. I think I have made my sentiments clear on that in recent economic indicator coverage on the NewsWire. Speaking of which....here are my most recent comments on the fate of the MBS purchase program:

Michael Fratantoni, MBA's VP of Research and Economics, summed up the environment PERFECTLY:

"Although rates remain low, there appears to be a smaller pool of borrowers who are willing and able to refinance at today's rates."

This is why we think the Fed will be able to exit the mortgage market at the end of Q1 2010. Thanks to weakness in the labor market and a mini-refi boom over the past year, the pool of qualified borrowers (refinances and purchases) has shrunk considerably. This implies mortgage loan production will be slow enough to allow the Fed to exit the agency mortgage-backed securities market without causing a major disruption in MBS supply and demand technicals.

WHO WILL PROVIDE DEMAND SIDE SUPPORT IN THE AGENCY MBS MARKET?

Regardless of rich MBS valuations, banks have proven themselves to be a stable source of demand side MBS support. If/when yield spreads (relative value) cheapen up as the Fed makes their move toward stage left, there will be more incentive for hedge funds and money managers to become more neutral players (instead of being mostly sellers). On top of these two sources of funding, Asian banks, who usually focus on GNMA paper, will likely follow the lead of US banks and maintain or increase their current level of interest in US residential MBS.  There isn't a better time for the Fed to make an exit...

MAKE SENSE?

Anyway I am done ranting for now...its running late.

President Obama focused on CREATING JOBS in his State of the Union. I felt like he communicated well with America, as usual. Actions speak louder than words so I tend to ignore political rhetoric. I do think he is focusing on the right things though....JOBS and INNOVATION. Sending people back to school is a major MUST DO as well. Before I say this I want to remind that I am a registered independent. READY???

I thought the Republican response was well written and delivered perfectly. I must say I like the fact that the Reds are promoting free market economics and competition. I am not a supporter of too much government intervention. Again...actions speak louder than words.

Stocks liked the focus on jobs...

 

JOBLESS CLAIMS WERE WORSE THAN EXPECTED

08:30 28Jan10 RTRS-US JOBLESS CLAIMS FELL TO 470,000 JAN 23 WEEK (CON. 450,000) FROM 478,000 PRIOR WEEK (PREV 482,000)
08:30 28Jan10 RTRS-US JOBLESS CLAIMS 4-WK AVG ROSE TO 456,250 JAN 23 WEEK FROM 446,750 PRIOR WK (PREV 448,250)
08:30 28Jan10 RTRS-US CONTINUED CLAIMS FELL TO 4.602 MLN (CON. 4.600 MLN) JAN 16 WK FROM 4.659 MLN PRIOR (PREV 4.599)
08:30 28Jan10 RTRS-US INSURED UNEMPLOYMENT RATE FELL TO 3.5 IN JAN 16 WEEK FROM 3.6 PCT (PREV 3.5 PCT)
08:30 28Jan10 RTRS-US CONTINUED CLAIMS LOWEST SINCE 4.576 MLN IN WK ENDED JAN 10, 2009

DURABLE GOODS WERE WORSE THAN EXPECTED


08:30 28Jan10 RTRS-US DEC DURABLES ORDERS +0.3 PCT (CONS. +2.0) VS NOV -0.4 PCT (PREV -0.7 PCT)
08:30 28Jan10 RTRS-U.S. DEC DURABLES EX-TRANSPORTATION +0.9 PCT (CONS +0.5) VS NOV +2.1 PCT (PREV +1.5 PCT)
08:30 28Jan10 RTRS-U.S. DEC DURABLES EX-DEFENSE +0.3 PCT (CONS. +0.4) VS NOV +0.1 PCT (PREV -0.7 PCT)
08:30 28Jan10 RTRS-US DEC NONDEFENSE CAP ORDERS EX-AIRCRAFT +1.3 PCT (CONS +1.0) VS NOV +3.1 PCT (PREV +2.7 PCT)
08:30 28Jan10 RTRS-U.S. DEC GEN. MACHINERY +6.0 PCT, ELECTRICAL EQUIPMENT -3.9 PCT, DEFENSE AIRCRAFT/PARTS +14.7 PCT
08:30 28Jan10 RTRS-US 2009 DURABLES ORDERS -20.2 PCT, LARGEST ANNUAL DECLINE ON RECORD, VS 2008 -5.8 PCT

The bond market doesnt seem to care too much about either at the moment.....

The 3.375% coupon bearing 10yr Treasury note is -0-04 at 97-19 yielding 3.667%. Above my 3.65% support level but still keeping positive progress intact by not breaking 3.68%.

The FN 4.0 is -0-03 at 97-17 yielding 4.235% and the FN 4.5 is -0-01 at 100-22 yielding 4.435%. The secondary market current coupon is 4.405%. MBS prices are off the lows of the day but failing to make much forward progress yet.

SIGN OF POSITIVE PROGRESS: 10s move back under 3.65% and the FN 4.5 breaks 100-24...


Data provided by Thomson Reuters
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Posted in:General
Posted by Roch Lemieux, III on January 28th, 2010 1:52 PMPost a Comment

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