We have a world class secondary market department and they are kind enough to send out weekly updates to us sales monkeys. I like posting it as it is both a great source of technical and anecdotal information. Please let me know your thoughts!
The Week Ahead in the Capital Markets - November 19, 2007
“Mandatory sales have been very strong relative to best efforts. The reason: mortgages are once again trading with ‘zero duration’ and hedge costs are low. When Treasury yields drop, the market thinks more rate volatility is ahead, mortgage-to-Treasury spreads widen, and mortgage rates do not change. When Treasury yields rise, the market thinks volatility will subside, mortgage-to-Treasury spreads tighten, and mortgage rates do not change. The former – rates down – has been mostly the case lately, and mortgage yields are trading a whopping 2.09% over five-year Treasuries. That’s the widest since 2003.
Jumbo core prices worsened relative to conforming in the past day or so, but not enough to call it a trend quite yet.”
Short-term rates remain volatile, and the market has begun trading at odds with Fed-speak. Fed funds futures are predicting – with 86% certainty – that the Fed will cut rates by 0.25% on December 11th. 0.75% of additional cuts are also priced in for the first half of 2008. Fed Governor Kroszner, on the other hand, said Friday that current Fed funds rates are low enough already to help the economy weather this “rough patch.” The U.S Treasury is also doing its part to assure global trading partners that a strong dollar is a high U.S. priority.
Meanwhile, “Level 3 assets” is the latest phrase to grab financial headlines, and financial stocks are getting trounced. The new accounting rule SFAS157 requires banks to divide their tradable assets into three “levels” according to how easy it is to get a market price for them. Level 1 assets have quoted prices in active markets. At the other extreme, Level 3 assets have only unobservable inputs to measure value and are thus valued by reference to the banks’ own models, according to PrudentBear.com. A number of leading banks and Wall Street firms hold sizable amounts of Level 3 assets, enough to incite fear among investors and send stock prices down another notch. As has been true with much of the mortgage meltdown, perception has trumped reality. Given that investors have little chance of understanding how these Level 3 assets will perform, most investors choose to sell.
As Warren Buffet notes, “When the tide goes out, you find out who’s been swimming naked.”
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