MBS React to Fed Move

Mortgage-backed securities reacted to the Federal Reserve’s move to cut the Fed Funds and the discount rate by 50 basis points, analysts from RBS Greenwich Capital said. MBS spreads are now eight ticks tighter relative to 10-year Treasuries for FNMA 5.5s. They added that dollar rolls are exploding,RBSGC said, with the October to December FNMA 6 roll current 6 plus bid. This, they said, would result in positive carry for mortgages. Meanwhile, Barclays Capital analysts said they are moving to overweight on the mortgage basis. Analysts said that the Federal Open Market Committee’s move was actually surprising. Considering this move by the FOMC, the firm is turning tactically overweight on the mortgage basis. The analysts gave three different reasons for this move to overweight the mortgage basis. They highlighted the fact, first of all, that a 50 bps move increases the possibility of considerable easing in the future. While analysts still think that the Fed would be stopping at 4.50%, the market, they said, will likely start pricing in a more aggressive easing. Barclays analysts added that the December futures contract is currently pricing in an additional 38 basis points of cuts. Even if analysts are right, and the futures market eventually proves to be wrong, the perception of much cheaper funding should help MBS in the near term, analysts said. Specifically, they expect overseas demand to pick up strongly in the near-term. Additionally, the rate rally as well as the spread tightening have moved the average dollar price of the MBS universe closer to par, analysts said. This actually eliminates many of the negatives that are associated with the speed slowdown. They said that a problem for the current mortgage market has been the poor financing in the dollar roll market, particularly for the back-month contracts. A reason for this has been the lack of willingness to finance for longer periods, analysts said, although the move tighter in short swap spreads implies that this factor might be going away. Barclays cautions the market that a fair amount of outperformance has taken place right after the FOMC statement. Analysts at the firm also said that dealer earnings from big mortgage shops could still pose an unpleasant surprise. They concluded that, on balance, MBS should do well in the next few days. But, analysts do suggest for MBS players to monitor the basis closely and to be prepared to take it off the overweight position if needed.