‘AI, Al, Captain!‘

Research evidence excerpt

‘AI, Al, Captain!‘

IdeaM

Market Recap

Rates twist steepened through a volatile news week. Middle East tensions and hawkish

rhetoric were balanced by downside surprises in CPI/PPI and tech sector weaknesses. Risk

assets were broadly unchanged on the week with vol flat to a bp lower, IG cash and CDX

unchanged, and S&P down 0.5%, though the Nasdaq was down 2.6% and is

underperforming today as we write this. Mortgages were modestly wider as the index

ended 1bp wider on the week, with Ginnies and 15s underperforming.

It's an interesting environment now that we're past the inflation data. Market pricing in the

July meeting is back down to less than a 1/8 chance of a hike after getting as high as a 45%

chance earlier in the week prior to the CPI release. If the Fed isn't going to hike in July, and

we're unlikely to get much forward guidance in the press conference, then one possible

path is that the market doesn't have much to move it beyond geopolitical concern until

we come back from the summer and see what the outlook is for the September FOMC

meeting. If that happens, we think the trade is sell vol/get carry, and MBS should do well.

Exhibit 2: Current coupon conventional OAS was unchanged Exhibit 3: 2s-10s was 4bp steeper, while 1yr10yr was

(and unchanged vs. swaps, not shown but look at MSCCSOAS unchanged on the week

Index) nVol 2s-10s

curve

CC TOAS Fed buying 140 240

Fed reinvesting No Fed buying

80 125 180

110 120 60

95 60

(bp) 80 0

20 TOAS

65 -60

50 -120

-20 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026

-40 1yr10yr vol 2s-10s curve (RHS)

Source: Yield Book, Morgan Stanley Research, Bloomberg

Source: Yield Book, Morgan Stanley Research Note: Since 2016, uses desk assumptions for deliverable,

instead of YB; as of Thursday close