We apologize for the lack of reports the last two days, but hopefully everyone locked last Thursday or Friday in advance of the historic drop we saw yesterday in mortgage backed securities (MBS). Though we had predicted a pull back from the highs reached last week, no one could have predicted the -175 bps that were lost yesterday.
After trading in a tight channel for the last two months, it was inevitable that bonds would come off these highs. With the positive news on consumer confidence and existing home sales, we are seeing a beginning of belief that the economy is final showing small incremental gains even within the most dismal of reports. Add to this a very real fear of future inflation with trillions in Treasuries and the continued need to print large amounts of money.
The yield between Treasuries and Mortgage Backed Securities has slowly been getting much tighter in the past week. Treasuries are the safest investment available, but they do not pay as much as other vehicles. MBS are safe, but with the issues in the housing market, they have become less attractive. Add to this a smaller difference in the yield, and traders in a flight to quality, placed their money in Treasuries rather than the slightly higher risk mortgage bonds.
Many are wondering and speculating that the Fed will step in to rescue MBS with further purchases. Unfortunately, the government is out of money, and to make up for the short fall, they will have to auction off more Treasuries. So in essence, in order for them to have the ability to purchase more mortgage bonds they will be forced to sell more Treasuries. This will further weigh on MBS, and will eventually lead to inflation.
All this being said, it is very doubtful that pricing will get back up to the levels we saw over the last two months. We will see some spikes and windows that will lead to lower rates than current levels. Still, the damage has been done, and those hoping to get back down to the 4.5% range will certainly be disappointed.
We did see a little bounce today, which should be expected after such a dramatic drop in mortgage backed securities. The Fannie Mae 4.5% bond closed up 34 bps on the day. Hopefully this can be sustained going into tomorrow’s trading. Of course, everything is a gamble as witnessed this past week.