MBS RECAP: The Range Finally Breaks, But Not The Way You Were Hoping

Super narrow consolidation patterns in bonds are always super boring until they’re not.  It looked like things may have been getting exciting as early as Wednesday of last week, but then Thursday brought a fairly convincingly rally that reinforced the 2.89% ceiling.  Rather than go into the weekend with a typically inconsequential trading day, Friday complicated the matter further by bringing yields right back to the ceiling.  With that, it fell to today to render a verdict.

As you’ve likely already guessed, the verdict was unpleasant for fans of low rates.  Bonds spent the entire domestic session churning toward higher yields, ultimately surpassing 2.95%, which was the next technical ceiling on our list.

So what’s up with all of this sudden weakness?

First of all, sudden weakness doesn’t need too much justification if it’s occurring as a part of breaking an ultra narrow range that’s been intact for roughly a month.   Also decreasing the need for justification is the fact that this wasn’t the biggest one-day sell-off we’ve ever seen (6.6bps in 10yr yields).

And if you still crave a tidy causeeffect explanation for today’s specific drama, you might be out of luck.  To be sure, there was no ONE cause that clearly prompted this break.  A decent amount of flattener positions (traders that had been betting on 2yr yields continuing to rise versus 10yr yields) proved to be dry tinder for a sort of pain trade.  Simply put, too many traders were positioned for one thing to happen, so when trading levels were pushed into a zone that prompted some of them to cover their bets, many of the rest of them were forced to follow suit.

Beyond that, we can talk about an unexpectedly big supply of new corporate debt doing some damage early.  There is also some talk around bond market campfires about the Treasury issuance outlook, both through the end of July and beyond.  I don’t find the latter too compelling because none of it is new news (i.e. nothing changed since last week, so why wouldn’t that have hit bonds harder last week).  

If you read other financial news, you might come across some updates on Japanese monetary policy overnight.  While it did contribute to pressure early in the session, the Bank of Japan not only pushed back against that pressure with words, but also with an unlimited bond buying program (something they do periodically).  This brought yields back into positive territory for the start of the domestic session.  All of today’s weakness consequently happened during domestic market hours and was a product of tradeflows from US traders.  

Article source: http://www.mortgagenewsdaily.com/mortgage_rates/blog/864939.aspx

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