Morgage Backed Securities: 3yr Auction Confirms Improvements

PRLog (Press Release) - Jan 12, 2010 -
Tsy Yields / MBS Prices "Ratcheting" In The Right Direction
Support From Overnight Action, Domestic Econ, and 3yr Auction
4.5's end the day UP 17 ticks to 100-18
10yr Tsy Yield DOWN over 10 bps to 3.715
All Eyes Remain On Auctions With 10yr Coming Up Tomorrow

Earlier in the day, we made mention of the "ratcheting down" of yields into progressively lower ranges.  The new year deposited us in uncomfortably high territory even after seasonal effects of December trading were given time to exit.  But with a solid overnight session gaining momentum from domestic econ data, the decision as to whether or not that momentum could continue rested squarely with the 3yr Auction.

The market even gave hints at the "ratcheting" phenomenon in that the morning trading used 3.75 as a support level in the 10yr whereas it had previous been a resistance level.  It was almost as if yields were given a sneak peak at the marble-lined corporate wash room and told "if we see a good 3yr auction, you can stay to watch the next auction results come in!"  Sure it would have made the metaphor easier to understand if it had ended with yields being "given the key" to the wash-room, but we all know that can't happen until/unless similarly supportive 10yr results and, to a lesser extent, 30yr results come in by week's end.

There might be something more to it than this depending on whom you ask, and for sure, one has to give a nod to Econ data.  But given that today's auction did more to move rates than a horrible NFP report (!), and that there isn't much to speak of by way of econ data tomorrow, we can at least agree that tomorrow's 10yr auction is a big deal.  In fact, it's potentially a huge deal.  It's the gate-keeper that will either allow bonds further blessing to explore this new, slightly better range (think one click of the ratchet).  

But just as we said about the 3yr today, there's no telling exactly where the morgage numbers have to fall in order for the positive scenarios to be more of a certainty.  Today's auction was very good, but not stellar.  And this seems to have been more than good enough for yields to grind lower.  With respect to AQ's previous discussion on the indirect bid, it's also quickly becoming apparent that although the trend is a trend, it's not meaningfully informing how bonds are traded in the wake of the auctions.  In other words, such a jump in indirect participation seems like it would have had a more desultory effect, say, in the middle of 09.  

To a certain extent, that indirect bid paradigm is something we've gotten used to as the morgage crisis escalated into full swing in 2009.  In that sense, if a paradigm shift truly is upon us, it's acceptable to us that the low %'s aren't having that negative effect on post-auction trading.  Certainly of much more concern are the additional layers of technical resistance lying ahead.  If bid-to-cover is in the mix with recent averages and the high yield manages to stay fairly close to WI, we stand an excellent chance to stay in this new range pending further info from 30yr auction and the rest of the week's data.

As you can see, the next resistance at 3.71 is even within reach tomorrow, but meaningful breakage there would require a decidedly positive morgage auction in the absence of the other dark-horse of the month: earnings.  But even if earnings AND econ data are bullish, the suggestion from considering NFP impact vs. 3 yr Auction impact is that the auctions trump all in the short term.  Again, a pretty quiet morning until 1pm tomorrow which brings the 10yr auction, followed by the beige book at 2pm.  Oh yeah...  Should probably also mention that if things kick off positive tomorrow morning, you don't even need to wait around for a blog post to expect morgage profit taking to moderate the rally.

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