Trading activity in the mortgage market so far this morning is thin and sporadic. Investors are staggering around as they attempt to pick-up-the-pieces following yesterday's stunning price beat-down.
The fuse of the price collapse the in mortgage market yesterday was lit by market participants' growing concern about the ever-expanding debt needed to fund the government's effort to revive the economy. These fears began to whip the winds of panic which was all it took to set off a powder keg of extension risk hedging (see yesterday's commentary for more on this subject) in the mortgage market. In the end, trading in the mortgage market completely devolved from rationally based transactions into a weak-kneed, thumb-sucking emotionally driven selling stampede.
As the dust begins to settle and the smoke clears - the last of this week's record tying $101 billion supply dump from the Treasury Department is still in front of us. The Treasury will auction $26 billion of 7-year notes today. The auction will conclude at 1:00 p.m. ET. This event will likely determine whether the credit markets begin to climb out of the crater created by yesterday's collapse.
The concern here is that the longer the maturity of the debt instrument offered, the more exposed the prospective investor will be to inflation, which erodes the value of the investment over time. The fact that Tuesday's 2-year note and yesterday's 5-year note auction were very well bid by both domestic and foreign investors offers no guarantee that these market participants will have a big appetite for today's offering. A well bid auction will likely build a base for at least a little "relief" rally in the Treasury and mortgage-backed securities market this afternoon. On the other hand, should the 7-year note auction be poorly bid - look for more selling pressure to wash through the credit markets as current holders of longer-dated government debt obligations and mortgage-backed securities look to get out while the getting is good.
As a side note the Fed was a "no show" in the mortgage market yesterday - and that was probably wise on their part. Why attempt to catch a falling knife when you can pick-it-up off of the floor in another second or two? Mortgage investors will be keenly interested to see, what, if any action the Fed chooses to take in the post Treasury auction trading session. Will the Fed move aggressively to buoy mortgage interest rates at current or fractionally lower levels - or are they willing to wait for further confirmation a meaningful bottom is in place? Quite frankly I don't have the slightest clue how the Fed will react - but it is safe to assume if they aren't buying - mortgage interest rates are not likely going to move notably lower.
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