Bond Markets Take Defensive Stance Ahead of FOMC, MBS Weaker


“It’s impressive that Fannie 3.5’s have held on to 102-20 as long as they have with 10’s inching closer to 2.03. With prices near their lows of the day and the cues from Treasuries looking unfriendly, we’re starting to get that “reprice risk” feeling. At this point, it’s nothing substantial, but enough to consider one of the characteristically early-to-act lenders could pull the trigger if MBS fall any further. Focus seems to be shifting toward next weeks FOMC and bond markets seem to be simply trying to hold out until then.”

That was the most recent reprice alert from MBS Live.  But whether or not a very small handful of lenders is considering repricing on any further weakness is the smaller consideration compared to potential break of the longer-term trends in MBS and Treasuries.  In other words, the day to day reprice alerts are convenient for aiding in the decision making process for short time horizons.  For example, if you know that you’ll probably lock something today or tomorrow, a negative reprice alert can help motivate the action.  If your time horizon is that short, now seems like as good a time as any.

But most time horizons are not that short.  So the big question is whether or not we are witnessing MBS break out of their longer term trend channel.  Clearly, prices have broken the lower line, but then there’s the historical caveat that we have seen this happen before, to roughly the same extent, without the trend ultimately being broken.  So in essence, we’re looking at a serious TEST of the trend channel but not a confirmed break yet.

Same exact story in benchmark 10’s

When we’re looking at these sorts of “breakouts waiting on confirmation,” it makes sense to look toward the upcoming calendar.  On the one hand we have ongoing Greek bond swap talks (whatever THAT means…).  I think it’s one of those things where something in Europe might or might not happen, and depending on which way it happens or doesn’t happen, it could have a small or large effect on domestic markets in one direction or the other.  None of that is a joke…  It’s the sad reality of bond markets for months now. Bottom line, ongoing headline risk out of Europe. 

On the other hand, there is an FOMC meeting/announcement next week as well as a round of auction supply on top of scheduled economic data–it’s a busy week.  The FOMC component of next week’s festivities will be a bit of a pioneering effort as it will be the first meeting where members forecasts are released in advance of the announcement itself.  Beyond that, the domestic economy has been seemingly improving recently, which would lead one to conclude there won’t be a marked uptick in dovish tone.

Putting all these together…

Headline risk out of Europe feels like it poses more downside risk for bonds than upside–that is to say, if Greek bond swap talks completely break down, it would be less of a surprise market mover than a convincing resolution.  Then there’s the unprecedented Fed forecasts.  Traders might not know exactly how other traders are going to treat this new component.  Then there’s the announcement itself.  QE3 is unlikely, but one has to wonder if some of the dovishness that previously has benefited bond markets might be curtailed due to recent relative economic strength.  Add in Treasury supply and more economic data and there are just too many reasons to retreat to the center of the longer term range and let someone else catch the falling knife. 

To conclude, we see the past few days of weakness in MBS and Treasuries as preparation for a highly uncertain week ahead.  Long-term, MBS is getting back to the middle of it’s range between 102 and 104 (fannie 3.5’s).  10’s are getting back to their last horizontal range of 1.95-2.10.  Remember that one?  Considering that this was the most recent significant range for 10’s, and that biggest hour of volume this year occurred when 10’s broke back above 1.95 in conjunction with the fact that yields are drifting out the door this weekend smack dab in the middle of this range, we think there could be something to this.  All that means is that things are looking unequivocally equivocal for next week.  Gutflop…

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