What happened last week?
Mortgage backed securities (MBS) gained 42 basis points (BPS) from last Friday’s close which caused fixed mortgage rates to move lower from the prior week. The market saw its lowest rates on Wednesday and its highest rates on Monday.
It was an uncharacteristically volatile week with a net difference of 83 BPS from the intra-week highs to the intra-week lows.
It was a very light week for economic data that had only a limited impact on pricing and rates. The biggest factor in rates last week was not domestic or global economics or inflation but instead it was an unscheduled bit of geopolitical shock that sent MBS soaring.
Wednesday was a very volatile day as MBS gained 50 BPS in one session (lower rates). This was due to the barrage of media coverage over a few liberal democrats calling for the impeachment process to start a special investigation over the firing of former FBI Director Comey. MBS rallied not in reaction to the politics of this but rather due to the view among long bond traders that this would mean important stimulative measures would be put on the back burner for some time. This includes tax reform, a stimulus package and regulatory reforms. These were widely believed to have a higher probability of moving forward just after the election and now are viewed as being stuck in yet another Congress that is deeply divided. Since the likelihood of those measures (which would have directly caused economic growth) has decreased (at least in traders’ minds) MBS rallied. MBS and other long bonds do best when expectations are for low inflation increase.
What‘s on the agenda for this week?
Just like last Friday, there is nothing on the economic calendar that can impact pricing today and just like Friday, look for a very narrow range with little to no change in pricing. But for the week, there could be plenty of volatility. If they operated in a vacuum, the technicals would have a lot of weight as MBS are trading in the “danger zone” and are well above any and all moving averages. This sets us up for the “leash effect” where pricing is snapped back to the nearest moving average. The issue this week is not whether MBS can make further gains…IF MBS can stay in this elevated channel. In other words, there is zero upside but the best would be a sideways movement. All it will take for MBS to move back into a lower channel is no new elevated Comey information, and/or OPEC increasing production cuts. Both scenarios have a high probability. As such, MBS remain in a locking bias (they moved into a locking bias on Thursday).
The three areas have the greatest ability to impact back-end pricing this week are: (1) Geopolitical Drama, (2) The Talking Fed and (3) Black Gold.
(1) Geopolitical Drama: In addition to the many “twists and turns” over Comeygate, there will also be more details of the President’s budget proposal and lots of headlines from his trip overseas. These will continue to be the main driving force in MBS pricing.
(2) The Talking Fed: The bond market no longer has two more rate hikes plus a tapering in the pace of MBS purchases by the Fed in the 4th quarter priced in. In other words, they do not believe the Fed. This week will be the minutes from the last FOMC meeting and a slew of speeches:
05/22 – Neel Kashkari, Patrick Harker, Lael Brainard and Charles Evans
05/24 – FOMC Minutes, Robert Kaplan
05/25 – James Bullard
05/26 – John Willams
(3) Texas Tea, Black Gold: OPEC will hold their meeting on Thursday. The key is if they extend the timeline (expiration date) of the current production freezes and/or actually increase the production cuts. Their action (or inaction) will have a big impact on global oil prices and MBS will react to any inflationary impact.
Treasury Auctions this Week
05/23 2 year note
05/24 5 year note
05/25 7 year note
As expected, it was an uneventful day as far as MBS trades, and is really just the “calm before the storm” this week before MBS move lower.
Chicago Fed Activity Index: A nice jump in production caused the April reading to be much stronger than expected (0.49 vs estimates of 0.10) and was a steep gain over March’s revised reading of 0.07.
On Deck for Tomorrow: Richmond Fed Manufacturing, 2 year Treasury Note and New Home Sales.