Treasuries were stronger today while MBS were mostly weaker. These days can happen, and they’re all the more likely when a few key variables are present. Among those variables are Treasury auctions, big geopolitical risks, and the monthly MBS settlement process. Incidentally, all three of those are in play right now, but we’re looking mostly at the after-effects from the MBS market’s extra volatile adjustment process that took place in March (and that is still taking place to some extent).
What needed to be adjusted? In not too many words, the existing infrastructure of available MBS coupons wasn’t set up to handle the precipitous drop in rates that began after the Fed announcement in March–a problem that can be traced all the way back to the higher rates at the end of 2018. October and November threw the MBS market for a loop by forcing a reawakening of liquidity in coupons that were all but forgotten in the post-crisis era.
In a nutshell, lenders were trying to throw loans across the room and into tiny thimbles as opposed to nice, big buckets. The less useful buckets were scrapped in order to build up the thimbles, but just as those became big enough for Oct/Nov volume, rates swung the other direction, thus obviating the newly renovated mega-thimbles. In March, those were scrapped, and the buckets that were just scrapped in Oct/Nov were suddenly called back into service.
In actual terms, demand for Fannie 3.0 MBS coupons (the bucket that contains C30 rates from 3.75-4.125%) enjoyed a mini golden-age of demand. Loans were originated and those 3.0s remained in high demand in order to satisfy March’s loan commitments. After the 30yr fixed settlement cycle for that crop of MBS (which concluded yesterday), Fannie 3.0s are back on more equal footing, and have thus given up some ground to Fannie 3.5 coupons.
But none of the above is here nor there when it comes to market movement. In terms of rate movement, however, we can say there was a relative frenzy in favor of MBS in March and the unwinding of that frenzy after those coupons were settled helps account for Treasury outperformance. With that, mortgages didn’t improve today even though Treasuries did.
Tomorrow brings the week’s biggest volatility risks with the Fed Minutes at 2pm, potential brexit headlines throughout the day, a 10yr Treasury auction, and the week’s first relevant economic data.