MBS CLOSE: Brave New World?
Recently, we've been starting off the PM notes with short term happenings and then examining them in the context of the longer term range trade. But today is the opposite. And though--yes it's true my friends--this is because we have FINALLY moved out of the longer term range, when we look at the long term breakout in the context of what the short term intraday movements tell us about the current trends in rates, the news is actually not as black and white as it might seem.
The bad part of the news is obvious... You're already aware of it if you've been reading today... Not to add insult to injury or to be sadistic in any way, but let's take a look at where today's action left us on the longer term chart:
Yes... After 4 months of failing to break above 100-10 for more than 2 days, finally breaking it, and not looking back for a full two months, the day has finally come... Treasuries suffered by degrees compared to MBS as the 10yr yield backed up to 3.556. MBS were down 11 ticks on the day to 100-08. You might recall that we discuss "statistically significant range violations" from time to time and that, although every analyst has different rules, our rule over the past few years has been to hold MBS to the following standard when breaking a trend:
- Must break by 3 ticks or more
- must hold at the resulting level or worse for 3 days (original day of breakout + 2)
- technical movements more discounted as settlement nears.
- some grace given to event risk
So although we are indeed outside the range, not only have we not met the "significance" requirements, but the concept of "event risk," is in play as well. Now what is THAT? You'll normally find "event risk" referring to the activities of a corporation that can affect their stock price. Interestingly enough, buybacks and sales of a companies stock or corporate bonds--planned and unplanned--are often sited as examples of event risk. So it might not be that much of a stretch--for our purposes--to consider event risk as referring to the analogous activities in bonds and MBS. Thus, this week's record auctions-- or "planned sale of bonds with as yet unknown results if you will--classify as bona fide bond market event risk. And it's with this in mind that we proceed.
Please don't read too much into the following. I'm not trying to soften the blow of the potential range breakout, or even argue that "everything will be ok." It might be... It might not... But I do want to convey to you that today's trade was one of the options we suggested for the breakout that leaves a lot more to chance than a catastrophic bond-negative realization. As it stands, both stocks and bonds weakened on the day, with the latter doing so slowly and gradually after recovering from morning weakness. In and of itself, this disconnection of the stock lever is the first clue for moderation... Further clues were available in the intraday charts...
Gosh... I know we were just talking about breaking out of the range, but if I didn't know this was an intraday chart, I might think this looks an awful lot like a .... like a range? Not only that, but after the initial weakness, the range moderated ever so slightly... Where have we seen this before? How about the massive amount of "honing" triangles we've noted recently where prices gradually narrowed a range in search of a status quo or a new price level?
Coming into this week, we knew we'd be up against the familiar enemy of pre-auction concessionary selling. Symbolically, you can think of this like the runner leading off the base... He might get thrown out at first, but there's a potential reward he wants to be ready for that makes it worth the risk... Same story for bonds with the upcoming auction...
Given the relative surprise of the demand situation that became apparent after the recent 30yr auction, positions are conservatively hedged for a confirmation of that weak demand for the shorter duration stuff. It's the same story we've seen time and time again over the past few months where markets are preparing for the worst. And in those recent months, the "worst" never came, and the conservative pre-auction positions unwound hand in hand with rallying MBS. I think the reason that Friday's move toward the weaker levels of the range was not enough of a concession is, in part, related to the last 30yr auction being the first major "let down" we've had in a while.
So although we are no longer in the range, it's not OFFICIALLY broken at the moment. And we find ourselves in a very similar position to auction week's past where, by far and away, the most critical events of the week will be occurring at 1pm the next 3 days. Hey... There's that "event" word again... Long story short, I know it doesn't look or feel good to be outside 3.5 in the 10yr, but in the absence of rallying stocks and given the past precedent of concessionary selling, (AND considering our recent discussions about yield or price levels "orbiting" significant technical levels!), I would say that it's the next 3 days mark the critical assessment period for the range as opposed to the moment occurring this morning where yields merely ticked to 3.5001...
Are you happy to have some variety in the market finally? or would you rather have your good old range back? If the latter, one very important market agrees with you... We'll discuss more about the why the tsy futures market can give such a different technical read than the cash market when we have more time, but for now, take a look at the last 2 months of 10yr futures... Here's one market at least, who is as yet abstained from the breakout voting... Nothing to infer from this other than we're still dealing with an undecided market, ready to move, for better or worse...
