What is MBS convexity?

MBS convexity refers to how the duration (interest rate sensitivity) of Mortgage-Backed Securities changes with movements in interest rates. It's a measure of the sensitivity of an MBS's price to changes in interest rates that aren't linear.

Why is the 10-year Treasury yield important for MBS?

The 10-year Treasury yield is a benchmark rate that heavily influences mortgage rates. Significant movements in the 10-year yield can trigger changes in mortgage prepayments and, consequently, the duration of MBS portfolios, leading to hedging activities that further impact rates.

How does MBS convexity contribute to rates volatility?

When interest rates change, homeowners' prepayment behavior shifts. If rates fall, prepayments tend to increase (duration shortens), requiring MBS portfolio managers to buy Treasuries to maintain duration targets. If rates rise, prepayments slow (duration extends), requiring sales of Treasuries. These large-scale hedging flows can amplify initial rate movements, creating a self-reinforcing cycle of volatility.

MBS: Convexity Stealthily Influencing Yields Around 10-Year Band

While MBS convexity isn't causing headlines today, its subtle influence around the 10-year Treasury yield band demands close attention. Understanding its dynamics is crucial for navigating...

In the intricate world of fixed income, Mortgage-Backed Securities (MBS) often operate beneath the radar until their underlying convexity flows begin amplifying broader market movements. Today, while not a headline event, the quiet dynamics of MBS around the critical 10-year Treasury band, currently at 4.040%, warrant careful consideration as markets head into the next trading session.

The Subtle Power of MBS Convexity

MBS convexity, a measure of how the duration of MBS changes with interest rates, is rarely a primary market driver on calm days. However, under the surface, these mechanisms are always at play. Traders often watch for moments when MBS convexity flows start amplifying moves, particularly in the US Treasury market. The US10Y realtime stands at 4.040% today, hovering within a narrow range of 4.022% to 4.059%. This stability might lull some into complacency, but it's during these periods of quiet that the stage is set for potential shifts.

When the 10-year Treasury bond breaks out of such a range, especially in a volatile regime, the duration of mortgage portfolios can extend or shorten dramatically. This forces hedging flows that, in turn, can reinforce the initial move, creating a self-reinforcing loop of rates volatility. Investors are keenly watching the US10Y price live, anticipating whether it will maintain its current poise or breach these key levels.

Key Metrics to Monitor into Tuesday’s Reopen

As we transition from the Europe close to the New York handover and look ahead to Tuesday's full liquidity print, several factors related to MBS and the broader rates market deserve close scrutiny:

10-Year Yield Breakout: Will the UST 10Y price live sustain a breakout from its current narrow band? If so, institutional mortgage hedge ratios could adjust abruptly, leading to significant market impact.
Elevated Volatility & OAS: Even if nominal rates remain relatively stable, persistently high volatility (with VIX at 21.20 today, indicating ongoing market uncertainty) can cause Option-Adjusted Spreads (OAS) on MBS to widen. This widening occurs as the value of embedded options within MBS becomes more sensitive to rates fluctuations.
Curve Shape Dynamics: The shape of the yield curve, particularly steepening driven by bear market conditions, can be particularly uncomfortable for mortgage hedgers who often face duration extension risks in such environments. We’ll be closely watching the interplay between the UST 2Y realtime (3.410%) and the UST 30Y realtime (4.699%) to discern any significant shifts.

MBS as a Mechanism for Rates Volatility

MBS inherently acts as a feedback loop in the rates market. As rates move, prepayments (and thus MBS durations) change, necessitating hedging activity that influences rates further. While today may not be one where MBS commands the financial headlines, its underlying influence is omnipresent. The current stability provides a valuable opportunity to re-evaluate assumptions and ensure position sizing aligns with potential future volatility. Understanding the nuances of MBS helps in anticipating broader market shifts, making the US Treasury bond live rate a constant point of focus.

Desk Checklist for Tuesday

For traders and analysts, Tuesday's market open will offer critical data points to assess the undercurrents:

Mortgage Duration Shifts: Did MBS durations extend or shorten significantly on the first major liquidity print? This will be a primary indicator of tactical positioning.
MBS OAS Widening: Was there any notable widening in MBS OAS, even if the UST 10Y chart live showed stable nominal yields? This would signal increased hedging costs or perceived risk.
Long End Drivers: Did movements in the long end of the Treasury curve stem from fundamental macro news or from mechanical hedging flows initiated by MBS portfolios? The US10Y chart live will provide crucial insights into these dynamics.

The quiet can often be as informative as the storm. Today's MBS dynamics around the 10-year Treasury band underscore the importance of continuous monitoring and proactive risk management in a market where convexity is always present, even when it's not loudly proclaiming its influence.