MBS RECAP: Another Day With Trade War in Focus

News

For the second straight day, US/China trade relation uncertainty dominated financial markets.  Volume was up across the board with Treasury yields and stock prices (SP futures, intraday) dropping to the lowest levels in more than a month.  Stocks eventually bounced back a bit in the afternoon, but nonetheless remain very close to 1-month lows.

At issue was last night’s news that Trump’s weekend trade tweets had teeth.  In other words, there really was a reason to announce increased tariffs on China to be implemented this Friday.  Between Mnuchin and Lighthizer, we were informed that the trade talks had soured and that China had reneged on previous agreements.  Lighthizer additionally confirmed the play to raise tariffs.  

Now… all of the above COULD be part of an elaborate negotiation strategy, but that’s not the sort of speculation that bond traders can afford to bet on.  Instead, they’re forced to account for possibilities just as they’ll be forced to react swiftly to any potential headline that makes everything “all better.”  The fact that it would really only take one headline to do that is incredibly unsettling, and a major reason for a major spike in implied volatility metrics so far this week.

MBS don’t like implied volatility!  MBS are also coping with a big surge in prepayment activity reported yesterday afternoon.  Between those two factors, there was no love for the mortgage market today, despite a 5bp drop in 10yr yields.  On the slightly brighter side, if something does come along to take the wind out of Treasuries’ sales, MBS would be less affected, but that’s still a fairly lousy consolation prize.

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