The first week of September was really about the last two days. Thursday held an important European Central Bank (ECB) monetary policy decision with heightened expectations given ECB President Mario Draghi's remarks this summer to "do whatever it takes" to save the euro. Meanwhile, Friday's employment report was seen as the key for determining whether the Fed would implement QE3 at its September meeting.

Given the pending events, Tradeweb volume over the first two days back from the Labor Day holiday averaged just 75%, but jumped to well above normal on the final two sessions as the ECB and non-farm payroll news sent the markets on a wild ride. 

Draghi seemingly delivered on his promise to "do whatever it takes" to save the euro and announced an unlimited bond buying program. This heated up the risk-on trade with the major domestic equity benchmarks surging between 1.8% and 2.0%, while the 10-year note yield soared to 1.673% from below 1.60% at mid-week.

Thursday also held an employment preview through ADP national employment report for August which came in stronger than expected, and led some economists to revise upward their outlook for nonfarm payrolls. The markets, however, were stunned by a 96k print that was well below the 125k consensus with July and June downwardly adjusted by a total of 41k. The 10-year note yield which was at 1.733% before the release plunged to 1.61% afterwards, or over a one point move in price, on expectations that the Federal Open Market Committee (FOMC) will announce QE3 next week.  

A result of both the sell-off and rally was a pickup in mortgage banker selling. Thursday through midday on Friday it totaled over $5 billion versus all of $3.0 billion over Tuesday and Wednesday. Thursday's supply was somewhat difficult to digest though lower prices and wider spreads did draw in opportunistic banks and money managers given the favorable technical outlook for the sector.

On Friday, however, originators could not deliver enough given the stronger QE3 odds and spreads on FNMA 30-year 3.0s and 3.5s were tighter by 1/4 and 1/8 point, respectively, at mid-day versus the curve and swaps. 

Outside of the usual focus on production coupons, there were some interesting flows over the course of the holiday-shortened week in other sectors of the mortgage market. One was in the FNMA 5.0 Sep/Oct roll which strengthened to 7+ ticks by Thursday's mark from 2 ticks on Aug. 31 due to shorts.  

Also, trading in specifieds was very active with originator cycle bid lists that reportedly totaled around $30 billion. This activity is typical heading into Class A (30-year FNMAs and FHLMC Gold) settlement which is next week, although the amount was quite elevated. Payups, however, held up well despite the supply as demand remained strong for call protected paper.

For the week through Thursday, Tradeweb volume averaged 90%.MBS performance was off to a good start for September with excess return to Treasuries on Barclays MBS Index at +15 basis points through Sept. 6. The 30yr current coupon yield rose to 2.53% from 2.44% at the end of August with the spread to 10-year notes two basis points tighter to 86. 

Excitement Continues

Providing a brief distraction earlier in the week for MBS investors as they waited for the FOMC statement will be the prepay news and Class A 48-hour day. The August prepayment reports actually will be out later this afternoon, but markets will only get a brief period to react if speeds are outside of expectations. So this will likely be more of the focus of trading on Monday and will also be an influence on dollar rolls heading into Tuesday's Class A allocations.

The FOMC delivers its policy decision at 12:30 pm on Thursday, followed at 2:00 pm by their Summary of Economic Projections, and then 15 minutes later Chairman Ben Bernanke will hold a press conference. Today's disappointing employment report with adverse back month revisions increased expectations that the Fed will not only extend the low rates time frame to late 2015 from late 2014, but that it will also announce asset purchases that will include MBS. 

Credit Suisse analysts said in research this week they expect buying of around $500 to $600 billion over 12-15 months. They calculated this would result in roughly 3/4 to 1 point outperformance on FNMA 3s versus rates and around 1/2 to 3/4 points on FN 3.5s. Barclays Capital's economists think the FOMC's buying will be "open-ended" and consist of both Treasuries and agency MBS. If they decide against an open-ended approach, they expect a stated amount of up to $500 billion extending into the first half of 2013.           

The week is not without events from the European Union which could potentially distress or buoy global markets. On tap are a German court ruling on the European Stability Mechanism (ESM), as well as, a Dutch election - both on Sept. 12; a two-day meeting of the euro finance ministers (the Eurogroup) on Sept.14-15, while Spain could possibly make its formal bailout request. 


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