The Treasury market took a breather last week, leaving yields little changed. At 0.614%, the 10-year note’s yield closed a little over a basis points higher than the previous Friday’s level, while the 2-10 spread steepened by about 5 basis points, as the curve “twisted” mildly around the intermediate maturities. With Treasuries settling into trading ranges, their realized volatilities have started to decline.
*The MBS Weekly Market Profile Report corresponds to the commentary below.*
This is illustrated by the accompanying graph, which shows the daily realized volatility of the 5- and 10-year notes using a 40-day lookback. (The 10-year’s 11.9 basis point level for 5/1 was calculated using daily price data back to March 6, which means that the extreme volatility experienced in late February and early March is starting to drop off the 40-day sample.) 
Click to enlarge One other notable development has been the decline in LIBOR rates. Since the middle of April, 1-month LIBOR has declined by roughly 50 basis points, reflecting improving market conditions and more confidence in unsecured lending. Note that lower funding rates have provided additional support to the MBS dollar roll market; for example, a 50 bp decline in funding costs on a 30-year TBA with a 2.5% coupon is worth roughly an additional 1+ ticks in the break-even roll value.
MBS performed fairly well last week, as the market experienced a decided up-in-coupon bias. 30-year Fannie 2.5s outperformed their 10-year hedge ratios by a cumulative 2/32s over the last five sessions, while 3s and higher ended the week between 5-7 ticks ahead of the 10-year. Ginnies had an even more pronounced bias; GNII 2.5s outpaced the 10-year by 3/32s while GNII 3s through 4s outperformed the Treasury by between 10 and 14 ticks.
Using our normal value metric, the Fannie current coupon spread reported 20 basis points tighter to interpolated Treasuries on the week, and (as shown in the graph below) the spread is approaching the level that it reported earlier this year. However, rather than a measure of improved sentiment, the sharp tightening of the index reflected distortions in how the measure is calculated and highlights the risks of using such metrics as measures of “spread” and “relative value.” 
Click to enlarge The current coupon rate is normally an interpolation between the coupon rate of MBS above and below “parity” (i.e., par with an adjustment for delay days and payment frequency), but when there are no discount coupons Bloomberg takes the lowest liquid coupon and calculates its yield based on the “median PSA” (i.e., prepayment speed) provided to them by a survey of dealers. This yield (adjusted for settlement days) is reported as their “current coupon rate.” Two things happened recently to grossly distort their current coupon calculation:
- Earlier in April Bloomberg began using Fannie 2s as the benchmark for calculating the current coupon, rather than 2.5s. This makes some sense since the price of FNCL 2.5s was around 104, and trading volumes and liquidity for FNCL 2s have improved. But…
- Up until late last week, only one dealer (Barclays) was providing model speeds for Fannie 2s to Bloomberg, which meant that the yield for the current coupon was calculated based on a single reported speed. However, a second dealer (BAML) reported speeds on Friday, and their model speeds were much faster than Barclay’s; as a result, the median (or in this case, the average) PSA used by Bloomberg went from 143% to 280%. At a 101-24 price, this resulted in a 16 basis point decline in the yield on Fannie 2s and a commensurate drop in the current coupon rate, away from any other changes in market prices or levels.
These types of issues are one reason that we have on occasion used the Fannie Mae commitment rate as a proxy for MBS spread, although there is no measure that isn’t subject to some degree of distortion over time. This episode also highlights the treacherous nature of using TBA “yields” and “spreads” as a measure of relative value and performance in the MBS sector.
About the Author: Bill Berliner
As Director of Analytics, Bill Berliner is tasked with developing new products and services, enhancing existing solutions, and helping to expand MCT’s footprint as the preeminent industry-leader in secondary marketing capabilities for lenders.
Mr. Berliner boasts more than 30 years of experience in a variety of areas within secondary marketing. He is a seasoned financial professional with extensive knowledge working with fixed income trading and structuring, research and analysis, risk management, and esoteric asset valuation.
Mr. Berliner has also written extensively on mortgages, MBS, and the capital markets. He is the co-author, with Frank Fabozzi and Anand Bhattacharya, of Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques, which was named one of the top ten finance texts in 2007 by RiskBooks. He wrote and edited chapters for The Handbook of Mortgage-Backed Securities, The Handbook of Fixed-Income Securities, Securities Finance, and The Encyclopedia of Financial Models. In addition, Mr. Berliner co-authored papers published in The Journal of Structured Finance and American Securitization. He also wrote the monthly “In My View” column for Asset Securitization Report from 2008-2012.
