MBS MID-DAY: Back to Pre-FOMC Levels; Here’s Why


Both MBS and Treasuries are back in line with trading levels from the close of business on Tuesday.  Today’s gains have been moderate during the domestic session, but border on extreme if we cound the overnight session.  For example, 10yr yields were as high as 2.655 and are now down into the 2.5’s.  That’s not the kind of movement we typically see on a day without any significant events to motivate trade.

So what’s motivating trade then?

As I said in Wednesday’s commentary after the Fed announcement, there have been other factors in play that could easily outweigh the anticlimactic response to the Fed.  Several of these factors are now conspiring to give us a boost.  We’ll talk more about these in the coming week, but here’s a short list for now.

  • First up on the ‘short’ list is ‘short-covering.’  This occurs when a trader takes a short position in rates (i.e. expects rates to move higher) and then is forced to buy in order to cover the bet if rates move lower by a certain amount.  Of course, short-covering relies on an organic source of market movement, but it certainly adds to the momentum created by other factors in this list.
  • European market spillover is also helping.  One of our leading theories on “other stuff” that could have been motivating September bond market weakness was that traders were disappointed after the ECB’s last policy announcement.  In short, there had been a good amount of hype for QE.  Draghi came out and announced a half-hearted campaign of ABS purchases.  Markets wondered “was that it?”  Commentary from the next few days suggested that indeed could have been the extent of the ECB’s bazooka for now.  But now we’re already seeing underwhelming statistics on the impact of the ECB’s recent easing measures.  The conclusion is that the ECB may yet be forced to open the monetary floodgates by an amount closer to what markets were originally expecting.  A bounce in European bond markets is taking serious shape today, more so than any other day in September.  It’s definitely helping.
  • Corporate bond market hedging tradeflows.  This is a complicated topic, but in an attempt to simplify it, let’s just say that corporations who issue debt also may use Treasuries to hedge their risk during that process.  The first part of the hedging involves selling Treasuries and the second part involves buying them back.  We might be seeing some of that second part now. 
  • While next week will be the better time to discuss it, the upcoming “quarter-end” trading environment could also be a consideration, especially when we consider that we’ve had our fair share of weakness recently.  Simply put, there’s a certain amount of forced bond buying that takes place at the end of the quarter and month.  Sometimes it’s noticeable, sometimes it’s not.  
  • Also worth more consideration next week is the technical landscape.  We touched on this briefly yesterday in discussing the active level of trading amid the narrow trading range.  All of the sideways grinding with the fairly impressive volume tally suggests “something” is happening, but there’s no great way to tell what that will be until getting a chance to see the next move.  One day of strength isn’t quite enough to conclude that yesterday’s sideways grind was indeed a strong showing of technical support, but it is enough to conclude that there’s a chance!

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