NOTE: It’s “Notification Day” for Fannie and Freddie 30yr Fixed MBS. That means that November coupons will no longer be traded after today and thus prices for November coupons will no longer be the representative “MBS price.” As always, the trailing delivery month (in this case, December) trades at a lower price. In a perfect vacuum with absolutely no outside influence on MBS prices, December’s coupons would gradually work their way back up to the outbound November coupon prices you see on your screen today. On this “roll” day, however, there will be a big apparent drop as screens switch over from Nov to Dec. Lenders are already well aware of the change and there is no rate sheet implication.
Bond markets began the overnight session little-changed, but improved during Asian market hours. European hours had no objection to this at first, but bonds bounced together around 6am and didn’t stop selling until the afternoon. Ultimately, about half of Friday’s gains were erased for production MBS (roughly a quarter point) and a bit more than half for 10yr Treasuries.
That weakness comes with serious caveats and raises serious questions. First for caveats:
1. Asian hours were active, but domestic hours were not. This suggests those left in control during the domestic session had an inordinate amount of impact on trading levels. Reason being: few market participants means buyers and sellers have to reach farther to make trades. In other words, if I have to sell my car today, and you’re the only buyer in town, the price will be a lot lower than if there were multiple interested buyers. Same story with bond markets today where Asian accounts were solid buyers early, but then punched-out by the start of the domestic session.
2. Corporate debt issuance added further pressure to the imbalance. Using the same analogy from above, let’s now consider several other people also need to sell their cars today and you’re still the only buyer. Now the price drops further. Corporate debt issuance creates extra sellers in the bond market. It normally wouldn’t be too much of an issue, but in a less liquid market, the effects are felt.
3. Snowballs can always roll. Trading algorithms don’t care why a particular level is hit, they just know they must sell when a particular level is hit. The organic weakness from the first 2 caveats hit these electronic trip wires, bringing more selling into the mix, which in turn tripped a few more triggers before leveling off.
1. Given the caveats, how shaken should our resolve be that Friday marked a turning point in recent weakness?
2. Is it still the case that today was an unofficial “day 3” of an unofficial 4 day weekend and are we still waiting for Wednesday and Thursday so see how this week truly begins?
3. Could it still go either way at that time?
1. Slightly shaken. It would have been much easier to brush off weakness if 10’s had held under, say 2.33 as it looked like they would this morning. That said, 2.36 doesn’t seem like the end of the world.
2. Yes, but it also revises Friday’s gains to be a lot less exciting
Conclusion: There’s still room for hope, but today’s action unfortunately doesn’t bespeak a market that was chomping at the bit to trade lower in yield.