MBS Investors Eye Treasury Yield for Spread Safety in Nervous Market

Buyers started the week nervous, a lasting sentiment reflected in the largely volatile credit spreads, corporates, financials, Treasuries and asset-backed securities (ABS). On Thursday the announcement that China does not intend to sell its European bonds, saw some pricing recover. The KBW Bank Index rose 3.99% to 51.09 and the Dow Jones Industrial Average rose 2.85%; the S&P 500 Index rose 3.29%. By the close of the market today at 2pm, stocks had fallen again on the news that Fitch Ratings downgraded Spain’s credit grade to double-A+ from triple-A. As result, the US long-term treasuries continue to maintain strength. US treasury yields fell to 10-month lows earlier in the week as investors flocked to the safety of US public securities. Since mid-April, the 10-yr Treasury yield has rallied over 53 basis points (bps) with most movement, driven by the market digesting the gravity of the sovereign crisis in Europe. According to Citi (C) analysts the rally has taken the 10-year and 5-year forward 5-year (5y5y) Treasury yields to about 25bps and 65bps, respectively. The yield on the 10-year note fell 7bps, or 0.07 percentage points, to 3.3% at 2:54 p.m. in New York, according to BGCantor Market Data. The 3.5% security due in May 2020 gained 18/32, or $5.63 per $1,000 face amount, to 101 22/32. Analysts at Citi said that the very front-end (2-year yields) were already at pretty low levels and this week’s rally has brought even some of the near forward rates quite close to historical lows. They add that the longer dated forward rates have more room to decline should the panic in Europe turn into a global financial crisis. “For example, the 1-year forward 2-year rate is close to post-Lehman lows while the 5y5y rate is more than 150bps above the levels seen at that time,” explained analysts. The MBS rate also picked up at by the close of market but opened wider today on the back of a fall in the stock market. The average US rate for a 30-year fixed mortgage fell to 4.78% in the week ending Thursday, from 4.84%, Freddie Mac (FRE) said. The record low is 4.71%. However analysts at Citi said that investor support for new production MBS may wane in a rally as US banks and foreign investors (currently significant sources of demand for agency MBS) are dollar price sensitive. Further, despite the rally in rates, many MBS investors are concerned about extension protection and in the case of rising rates, 30yr 4.5s could become very long securities. “Currently, the majority of 30yr 4.5s are currently held by the Federal Reserve and with its MBS purchase program over, other investors need to add what could be a growing number of lower coupon MBS,” said one analyst. The Markit iTraxx Senior Financial index also came in nearly 10bps tighter than from the wides seen last week. The index closed early in the week at 175bps and 166bps last Friday. Two weeks ago it was at 129bps and the low 60bps area in January. The author holds no relevant investments.