MBS Day Ahead: Bonds’ Momentum Problem


We talk about “momentum” a lot when it comes to bond market movement.  I like reducing financial market concepts and reducing them to easy-to-understand analogies.  

Sometimes a simple momentum analogy is that of swimming.  It’s easier to swim with the current vs against it, etc.  But a better analogy for moves like this one would be the following:

Imagine you’re in the streets of Pamplona, minding your own business, when a vague rumbling crescendos into the thunderous cacophony of thousands of tons of bestial rage driving hooves against stone.  You might not even need to see a set of sharp horns coming your way before you decide to turn around and run, but there’s no question, EVERYONE in the street is going to turn around and run.  You’ll run until the risk of getting gored or trampled has clearly passed, or until you simply cannot run any more.  You’ll duck into the narrow nooks and crannies of side streets and shop windows, and wait out the storm.  But in no conceivable case would you ever walk back up the middle of the street.

And so it goes with bond traders on days like yesterday and today.  Many run for a bit and duck out to safety (i.e. close out positions and wait for their next move).  Many continue selling because they know more selling will follow (i.e. short-term traders looking to make a quick buck).  Many let the fear take hold and run for their lives, farther and faster than they really needed to (i.e. selling more bonds at lower prices than needed, simply to make sure they get sold quickly).

Bottom line: everyone is selling.

It will stop, but we don’t know exactly when, or what that will look like.  It could be today, or it could take longer.  With today being the Thursday before a 3-day weekend, and some kids out of school for a 4 day weekend, more than a few traders may be transitioning into “holiday-weekend mode.” Thus, the willingness to rock the proverbial boat would be lower than normal. A lot can change by next Monday, so traders won’t want to be exposed to unnecessary risk over the weekend.

Then there’s the auction cycle. Yesterday’s 10yr auction was rough. We can assume today’s 30yr auction will face similar headwinds–especially in terms of foreign demand. Here too, the long weekend doesn’t help as a 1pm auction contends with the fact that market participation/attention/conviction tends to drop off sharply in the middle of these “days before 3-day weekends.”

These 2 themes alone are enough to give pause to buyers looking to step back into the bond market with these more attractive buying levels. But then there’s the constant elephant in the room of the early December European Central Bank announcement where multiple officials have either anonymously/indirectly/expressly said that the topic of tapering asset purchases after the March 2017 expiration WILL be addressed. The way the “hints” have come out makes it seem that the ECB has something to tell us that it’s pretty nervous about. That’s my take on them anyway, from a psychoanalytical perspective.

Here’s what all of the above has done to our previous uptrend.  This is a “reset”; and end of the trend.  We’re now looking for a new trend to emerge and in limbo until it does.

2016-11-10 Treasury Trend

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