A bit of housekeeping before we get to the UMBS question…
Bonds have have been rallying very well since yesterday morning. At the same time, the yield curve has been flattening back into more inverted territory seen for most of the past month. In other words, some of the “oomph” behind the rally could be attributed to yield curve corrections as the market perceives higher odds of slower growth in the years ahead. While the resilience is a welcome change of pace, we continue to view this week as another installment of “range-finding” ahead of more consequential events.
Here’s the same chart from yesterday (updated with today’s trading) showing the current consolidation range and the previous example. Again, this may expand a bit before getting to next week’s meatier events, but the general concept remains: range-finding and waiting for the most important data/events to comment on the next move.
To be sure, the gains have some foundation (i.e. it’s not entirely a factor of yield curve corrections). We can actually observe evidence of the market pricing in some small amount of of “pivot” from the Fed. Just (continue to) be aware that a “pivot” would only refer to the Fed shifting gears toward slower rate hikes and then to flat, high rates for as long as possible.
Same chart, longer time horizon:
Now moving on to the topic of MBS coupons. We’ve received so many incredulous questions about our insistence on using 5.0 UMBS as the benchmark for intraday market movement when those coupons only accommodate rates up to 6.125%. Understand that the coupons that actually correspond with available rates are simply not trading like 5.0 and lower coupons are (5.5s are getting close, but 6.0s are silly still).
While these lower coupons don’t align with rate sheets, they do provide a transparent base camp for price discovery. Lenders and market participants use these agreed-upon touchstones as a foundation to arrive at prices for higher coupons, but over intraday time frames, those higher coupons are NOT necessarily accurate representations of how MBS prices are moving. Thus, you would absolutely NOT want to be looking at something like a 6.0 or 6.5 coupon and expecting it to be remotely reliable in terms of reprice risk or even as a commentary on momentum. In fact, when it comes to something like a 6.5 coupon, if you look at the wrong time of day, the price could be catastrophically different from reality.
If all of the above is a bit dense for you, just consider the following chart and note that “lower = better” in terms of MBS coupons being relevant to track intraday changes in the mortgage market. A VERY clear theme emerges: nothing above 5.0 should be trusted on the same level as 4.0-5.0 coupons. Because 5.0 is the closest to reality while still being in that club of “most liquid,” it’s the obvious choice until 5.5s close the gap.