MBS MID-DAY: Holding Overnight Gains Ahead of Week’s Final Auction


Bond markets were slightly weaker during Asian hours, but got their groove back during the European session.  This wasn’t so much a factor of economic data (which was generally in line with expectations in Europe) as it was about volatility related corporate bond issuance.  Lately, that’s been a net-negative for bond markets as firms frequently sell Treasuries (directly or indirectly via swap contracts) to “lock” their borrowing costs between the time their bond offering is announced and when the bonds are actually issued.  But the volatility goes both ways because the firms can exit those hedges by effectively buying back the previously sold Treasuries.

All of this “stuff” also happens in Europe, and Europe has also been in the midst of active year-end corporate issuance.  As these deals work their way through the system, these hedge buybacks provide periodic boosts for bonds.  Today’s overnight session was one such boost.  So if anyone asks you why rates were marginally lower this morning, you can take 2 deep breaths and boldly declare  “rates were a bit lower this morning because firms that had previously sold government bonds to hedge interest rate exposure during the corporate bond issuance process are now buying back some of those hedges.”

All that having been said, US Bond markets remain anxious relative to European bond markets.

2014-11-13 Treasuries vs Bunds

This is both a short and long term phenomenon largely based on the fact that the EU is unequivocally ‘screwed’ in an economic sense.  Their death spiral provides ongoing support.  We get a more volatile and slightly less bullish version of the rally and life goes on.

2014-11-12 bund tsy 2

10’s are currently holding on to those modest overnight gains and have done a good job establishing some impromptu support at 2.365.  Fannie 3.5 MBS are similarly holding supportive levels at 103-04. 

This relatively uneventful and slightly positive morning could be working against us to some extent, however, as it could make the impending 30yr bond auction more difficult.  As we discussed yesterday, it’s not uncommon to see the trading community “make room” for impending bond auctions by trading current yields higher.  And we’re not seeing an outright concession today (though we arguably are seeing one relative to related markets or relative to where we might otherwise be trading if there were no auction ahead).

To make matters just slightly worse, today’s auction could be a bit more challenging than normal.  CRT Capital Group’s David Ader notes that seasonal factors put it at an implied disadvantage as November 30yr auctions have come in much higher than expected on average over the past 6 years. 

The silver lining, of course, is that after the auction, supply is out of the way for this week.  So to whatever extent auction preparations/uncertainty have accounted for some of the frustratingly persistent weakness, even a poor auction could be taken in stride.

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