Thursday, July 17, 2014

FLASH UPDATE: TRV Weekly Commentary

TRV Weekly Commentary
Week Ending 15 July 2014


Comment:
Week-over-week, hedged mortgage performance was flat.  Although origination in FN 30s was lower by ~ $2.0 bln, the basis was unchanged at 154 bps over the 5yr yield.  Our regression model estimates that the basis is wide by approximately 2bps, but we remain cautious for now given roll weakness and Fed tapering.

Last Thursday, headline risk relating to Portugal’s Banco Espirito Santo debt drove the 10yr yield down 5 bps early in the trading day.  Fear of contagion monopolized headlines as a strong initial jobless claim print (304k vs 315k expectation) had little impact on Treasury yields.  10yr yields have since been range bound between roughly 2.50 and 2.55 for the remainder of the week.  Range-bound yields have helped the refi index remain relatively stable, as evidenced by the refi index.  Similarly, the purchase index is lower, which is expected as summer seasonals cool.

The week has extended a period of low volatility, with an implied value on the 1m x 10yr swaption remaining at 59 bps.  Furthermore, the basis neither widened nor tightened prior to Yellen’s testimony to Congress on the state of the economy.  Many raised concerns that Yellen would convey a hawkish message given recent signs of continued economic recovery.  These concerns subsided, as Yellen’s message to Congress was congruent with previous Fed communications.  Yellen expressed concerns regarding risk-taking in corporate credit.  If spreads on high-yield issuers begins to widen, other spread products (such as mortgages) may widen as well.  We await technical factors or economic/geopolitical headlines to provide short-term trading opportunities.

We continue to remain neutral on the basis.  Low volatility has stripped away short-term trading opportunities, so we continue to monitor the G2 3.5 and DW 3 flys and are constructive on their performance.  Out outlook on the G2 3.5 is especially constructive, given the price is currently -2.2/32nds!

Noteworthy:
According to an article in the NY Times[1], many hedge fund managers agree that the Fed is behind the market regarding the strength of the economy.  These investors take a more hawkish stance than the fed, and opine the need to hike rates sooner than currently anticipated.  One manager pointed out that the current unemployment rate (6.1%) is below the threshold at which the Fed has historically acted. 

The disconnection between the Fed and the market creates the risk that market may be caught off guard if the Fed hikes rates sooner than expected.  Likewise, premature anticipation of a hiking schedule could be equally costly if bonds continue to rally.  Either way, it will be interesting to see how the Fed’s unprecedented stimulus will ultimately unwind.
  
Regards,

Tradex Global Advisory Services, LLC
investorrelations@thetradexgroup.com 
203-863-1500
@Tradex_Global

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