Leak Discovered Revealing MBS Trading Direction!

By: Matthew Graham •

Wait what?  The title is appropriate... you just have to note my sarcasm.

I was trying to think of a way to convey the following: we really hope that recent weakness in MBS prices hasn't been a surprise to anyone.  Judging by the conversations in the live chat window on the MBSonMND Dashboard, we are finally getting a sense that our reasons for favoring a lock bias over past two weeks are becoming clear to subscribers. 

Just in case you've missed it, here's what's going on... (short version)

  • Bond market looked overbought after 10s touched 3.18%
  • Higher yields expected because it was overbought + auction supply + NFP hedge + most harrying moments driving FTS bid fade from memory
  • 3.40/42 broke, and that meant something slightly bearish from a technical standpoint. 
  • Conclusion: all signs point to yields higher than 3.40/42 this week and their attempt to find the next "entry point" for bulls (bulls want rates to go lower, but need an entry point high enough in yield to entice buying)
  • Conclusion Part II: We're still able to entertain longer term price gains in MBS market
  • Conclusion Part III: Uneventful or weak econ data would reinforce that search for a bullish entry point, extremely positive economic data (and/or negative auctions) increase the liklihood of examining even higher technical levels like 3.70

That's about the size of it.  Does it make sense?  Here's how we put it on Friday: Key Support Broken.  Auction Supply Ahead.  And if you're not the link opening type, here's an excerpt:

After stagnating near key inflection levels for what felt like an eternity,  the 10 year Treasury note has broken through a cluster of support between 3.40 and 3.42%. This directional move started last week as a technically-driven upward drift from overbought levels (3.18%).  A corrective winning streak for stocks combined with a steady trickle of hawkish Fed rhetoric then contributed to further weakness in bonds. Now today fixed income investors are using the bearish technical environment to build in a price concession for next week's $99 billion Treasury auction schedule ( 2s/5s/7s). More simply put, there has been little push back against this sell-off. Flows have clearly favored fast money short sellers. Bid wanted....

Another important point from that post which dovetails into tonight's charts:

Plain and Simple: The market has largely ignored economic data and breaking news headlines all week. Investors have instead based their decisions on trading technicals... which are now looking bearish.  But volume hasn't confirmed those bearish technicals and it just so happens that we've got $99 billion in 2-year, 5-year, and 7-year debt on the auction block next week. There are no coincidences on Wall Street. Unfortunately while our gut tells us this back-up is temporary, our brain forces us to remind you of what's currently moving the bond market: TECHNICALS. And what might be at stake for mortgage rates....

The charts couldn't be playing out any better in terms of reinforcing the idea of a technically controlled market.  It's scary how logically it's behaving right now... Seems to suggest A TON of uncertainty about what happens next.  Simply put, using 10yr yields as a benchmark in the two charts below, we don't see bonds doing anything aggressive or dangerous.  Yields are staying inside extremes, meandering between various rungs on the technical ladder, leaving options open, and taking no risks.  In fact, they've sought out the most highly travelled and central level of technical significance near 3.49. 

The above chart is drawn with horizontal yield levels in honor of the sideways trading mentality that currently pervades the bond market versus the directionally trending mentality that fought back from high yields.  But what about that bullish trend?  Is it still alive?  In our view, very much so, but please understand that being "very much" alive isn't any guarantee of continued life, simply a heads-up that we're still entertaining positive and negative eventualities in the current market.  Doing anything else doesn't make much sense given the limited clues as to impending movements.

After the white circle, note the big bounce off the lower red line...  If you like the idea of a technically traded trend channel, once traders saw that bounce materialize, wouldn't it make perfect sense to take yields right back up to the other side?  Jury is still out... We have another auction to get through, and NFP to cast the final vote...