Mortgage-backed securities players are skeptical about the usefulness of a new futures contract on the Current Mortgage Price Index, launched Friday by the Chicago Board of Trade, arguing that the over-the-counter market already provides sufficient, liquid tools that can also be more closely tied to current production. But according to DW sister publication Bond Week, at least one buysider sees potential for using the contract to make basis plays. Officials at the CBOT did not return repeated calls.
Laurie Goodman, an MBS analyst at UBS Warburg, said the contract has several key drawbacks. What the contract offers is already offered on a liquid, efficient basis by either regular pass-throughs, or collateralized mortgage obligation derivatives, like interest-only securities and principal-only securities. Secondly, the contract allows little room to vary coupon selection. The futures, as well as the options on the futures, will also be derived from a weighted-average of the top issuance coupons over the past three months. In other words, the contracts launched Friday will be determined based on the issuance from December, January and February, with the most frequently issued coupon getting a 50% weighting, and the other two 25% each.
One head of a pass-through desk in New York called this product "a solution in search of a problem," as he listed the various ways in which dealers and originators can hedge new inventory, including swaps, other MBS, agencies, govvies and so forth.
But one trader at a large West Coast money manager was not so quick to dismiss the contract, reasoning that the contract merits a look if only as a way to play the mortgage-agency and mortgage-Treasury basis, given that both Treasuries and agencies (in the 10-year sector) have futures markets.
Goodman also shared this assessment, remarking that nearly 55% of the volume in agency contracts on the CBOT is spread related.
Goodman noted that there are some advantages to playing a mortgage futures contract over a bond, including a possible reduction in counterparty credit risk, and pricing transparency, but these likely will be trumped by the issue of liquidity. Similarly, she reasoned that the best attribute of the contract, assuming it survives, would be to allow dealers to get short low-production coupon series more frequently, thus avoiding the period squeezes that affect market pricing.
To provide liquidity for the contract, there will have to be an immediate interpretation in the mortgage originator community that their hedging needs are not being met in the collateral market, which Goodman does not believe is the case. This is particularly true given that the specialist firm making a market in these securities lacks the capital of either the dealer community, and so cannot position large blocks of securities inter-day, as a dealer frequently can.
