MBS RECAP: Bonds Pull Back After China Changes Its Mind


Let’s keep it simple tonight, because it really is pretty simple.  It’s all about China still–perhaps with an assist from a weak 10yr auction.

Chinese currency valuations are state-controlled.  The Peoples Bank of China (PBOC) set the exchange rate every day, and limits the amount that it can move.  There isn’t some published website that announces this policy.  There are simple state-controlled banks that will do as they’re told by the PBOC if the PBOC wants something else to be happening. 

Yesterday’s news was that the PBOC was going to free the nation’s currency (yuan, or if you’re pretentious, renminbi) to move where it will, based on market forces.  They assumed (correctly) that the currency would weaken, and this is what they wanted.  At the same time, it satisfied critics of the longstanding policy of manipulation and interference.  Win/win, right?

As it turns out, there is too much of a good thing for China.  As today’s slide surpassed yesterday’s, traders noted that state-owned banks began aggressively selling US dollars vs Chinese Yuan.  This is the PBOC’s way of saying ‘that’s enough selling for today.’  And who even knows what they’ll do tomorrow. 

Whatever the case, bond markets had been benefiting from the panic caused by the Yuan death spiral.  So if the PBOC is going to step in and stop the Yuan death spiral, bonds are going to stop benefiting, and they did!  Right after the Yuan bounced, so did Treasuries (in overnight trading).  Much of the pull back had already occurred by the domestic session.  A strong bounce in stocks and a weak 10yr Treasury auction helped fuel a more substantial pull back in the afternoon.

All told, bonds went out right around unchanged on the day.  That’s not too bad considering the pace and scope of yesterday’s rally.  The way we got back to ‘unchanged’ makes for a bit more anxiety.  If China steps in to keep the Yuan’s descent nice and orderly, it won’t be nearly as beneficial for Treasuries and MBS as it looked to be yesterday. 

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