MBS CLOSE: Post-FOMC Relief Rally Lasts All Day
Time and again we've encountered and done our best to give sufficient coverage to the concept of pre-data concessionary hedging. This is the phenomenon where rates rise, sometimes past established ranges, by way of positioning themselves for multiple outcomes from a significant piece of economic data or event. The bigger the potential movement tied to that event, the farther away from recent trends rates must go to be prepared to capitalize on weakness.
Sure, such events have always stood the chance to push rates in either direction, but in winter 2009, we haven't been operating in a band of technically motivated historical high yields--far from it. If that were the case, you might see the concessionary hedging "fade" the status quo by testing the lowest yield limits in recent ranges. But as we've been so consistently under 3.5% this fall and winter, and knowing full well that these yields must eventually rise as the economy recovers and quantitative easing subsides, remaining in those lower yield ranges ahead of potentially bearish events would be akin to "the safe" bet--aka less risk, less return.
By getting an aggressive "lead off," investors are in a less dangerous position should a sudden momentum shift occur. If their positions are too long compared to the rest of the market, they could face steep losses by the time they were forced to get on the "short bus."
All of the above highlights past experiences ahead of so many treasury auctions this year. Prepare for the worst and hope for the best. And a relief rally in bonds follows the event that turns out to be, at the very least, something other than "the worst." It was with this in mind that I brought you the timeless classic "Max Hedgeroom" in reference to yields moving outside the 3.56 level. We held out some hope, or perhaps it would be better to say we did not completely dismiss the possibility, that this was yet another epic "lead off" where bonds were ready to make a mad dash to 3.75 or thereabouts.
This time around, there was not as much reason to EXPECT more of the same "relief rally" behavior given year-end, mounting chatter on FOMC unwinds, and dependably "less bad" econ data. But after the relief rally began to form yesterday afternoon, gain some steam overnight, maintain the trend into the domestic open and continue through today's close, a relief rally following big-data-event concessions is exactly what today appears to be.
Take a look at the charts AQ just posted in MBS Afternoon.
Certainly, this AM's data doesn't justify a half point tear in MBS and a 10bp+ day for the 10yr. Without the aforementioned forces brought to bear by the relief rally, this would have been just another decent day. All this has the added benefit of putting the weakness leading up to yesterday in a clearer context. Plainly put, bond markets are not suffering from a mysterious ailment that will inevitably destroy them. They are very much in the same holding pattern, but briefly gave us a taste of the outer limits.
In the tsy portion of these long term charts, the teal line rests just slightly north of 3.48. Call it 3.48+ or 3.49 or even 3.5. Any way you slice it, there is a band of quintessential inflection surrounding these yields. Dropping the Greek, what I mean is that for most of the year, if yields haven't been higher, they've been lower and vice versa, as opposed to doing a lot of noisy trading back and forth across that band. Instead 3.48 has been more likely provide a bounce regardless of it's role as resistance or support. That understanding provides the backdrop for considering that this is where yields ended up today. So history suggests we're not as likely so dance around these levels as to move away from them in one direction or another. aka Inflection and/or pivot.
The red line shows 3.20 coinciding with lower support on a downwardly sloped trend channel (white lines) a few months back and then catching 3.2 again about a month ago. If things were to go just swimmingly for bonds, that's a tough cookie to crack and very likely holds more water than the trend channel support. But with yesterday providing a perfectly placed THIRD test of that trend channel's resistance, I'd say we should be keeping an eye on that resistance line with extreme vigilance. Seems like a great candidate for an indicator of shifting trend after yesterday.
Speaking of shifting trends, no major significance to this yet, but it's worth mentioning at least that the S&P is now two days below its most conservatively sloped long term support (red line) even though it CONTINUES to bounce back and forth like so many bumper-bound pinballs in its recent range (yellow lines). If the lower end of that range breaks, we'll find the S&P below both the short term and long term trends--a good sign to whatever extent the stock lever is in play.
Tomorrow is another quadruple witching (options and futures expirations) devoid of scheduled data. It will be interesting to see the volume turn-out tomorow as it's basically the last day of the trading year (heavy absenteeism on the street starting monday). Also, any google search or CNBC pundit will tell you how volatile such days can be, so maybe we should too, just in case it is... Throughout the year, we've seen them wear both hats, so as always, better to be prepared for action and not need it than need action, but be unprepared to take it. If things move enough in one direction or another such that action becomes recommended, you can be sure we'll let you know when, why, and how much.