After outperforming Treasurys by 46 basis points (Barclays MBS Index) over Thursday and Friday in the week of the Federal Open Market Committee's (FOMC) QE3 announcement, last week began with active selling from money managers and hedge funds.
Added with average supply, it was too much in fact for the Federal Reserve to absorb despite its voracious appetite that equates to a $4 billion per day average. By Tuesday's close, the index had given back 14 basis points.
It was somewhat perplexing given the expectations of Fed buying at a $40 billion monthly pace through the end of 2013 on top of reinvestment of paydowns running at roughly between $20 and $30 billion per month.
Investors, however, had been anticipating and preparing for QE3 action since spring so it was only natural for profit taking to emerge especially with quarter-end approaching.
The supply/demand technicals improved beginning midweek as selling slowed and money managers, REITs, pension funds, banks and fast money became better buyers down in coupon, along with the Fed. Buyers reportedly outnumbered sellers on the order of 3 and 4 to 1. Meanwhile, mortgage banker supply was slightly below normal at a $1.9 billion per day average.
Between the demand, lack of supply and selling, along with increased risk aversion globally on growing concerns about economic growth, prices on 30-year FNMA 3.0% through 4.5% coupons were at new price highs by Friday's 3:00 pm marks.
The commencement of QE3 MBS buying was reflected in the latest report from the New York Federal Reserve Bank as net purchases surged to $17.5 billion in the week ending September 19 compared to a $6.5 billion weekly pace over the previous several weeks. Of particular note was a pickup in buying in 15-year MBS to 16% of purchases from a 12% area in the prior two weeks and versus a 10% average going back to last October. Meanwhile, buying in GNMAs held in the 17% area, which was close to its historical experience.
In other activity, dollar rolls eased off their post-FOMC increase. However, the FNMA 3.0 and 3.5 roll remained better bid; 15s lagged 30s in lower coupons, while GNMAs/FNMAs were narrowly mixed. Specified trading picked up midweek with interest finally emerging again in 3.5s due to lower payups that result from the specialness in dollar rolls; meanwhile 4.0s saw steady demand, including from structured desks.
On the horizon in specified trading should be stronger interest in geography collateral – specifically paper consisting of New York, Florida, Connecticut, New Jersey and Illinois loans, as g-fees in these states are expected to increase between 30 and 15 basis points. The Federal Housing Finance Agency released its proposal on State-Level Guarantee Pricing and they anticipate it taking effect in 2013. For more information, see here.
Volume was lower on the week versus the prior week with Tradeweb averaging 108% compared to 120% previously. Excess return to Treasuries on Barclays MBS Index was negative seven basis points through Thursday with the month-to-date at 59 basis points, while the 30-year current coupon yield declined four basis points from the prior Friday to 2.37% with the spread to 10-year notes widening five basis points to 59.
For the foreseeable future, the supply/demand technicals remain very supportive.However, investors will try to take advantage of investment opportunities as they present themselves. This coming week has the potential for creating some better entry opportunities through $99 billion in Treasury supply (2s/5s/7s) beginning Tuesday through Thursday, and profit taking associated with quarter-end window dressing.
At the same time, it is the final week of September and indexers are likely to show up on Friday afternoon although their participation may be relatively modest as the initial extension read on Barclays MBS Index is just 0.07-year compared to an average September extension of 0.10-year.
Europe is likely to be in the headlines because of Spain and its bailout and this may temper investors' appetite for risk. The country is scheduled to release its budget for 2013, while an audit of its financial sector will be out on Friday.
In regards to the economic news, it is lightweight over the first half of the week with the more top tier items occurring on Friday with Personal Income, Chicago PMI and Consumer Sentiment.