Bonds Get Crushed as Stocks Take Desperate Measures
After stagnating for six straight sessions, benchmark interest rates finally broke technical support today and erased a chunk of positive progress.
Bonds got going in the wrong direction late last night after Chinese officials reported a 34-month high in consumer level inflation and better than expected industrial output. While this news helped stocks extend a recovery bounce that began yesterday afternoon (following a test of long-term support), bonds really didn't feel the pain until U.S. data flashed at 830am. We'll focus on the consumer-related news...
Retail sales fell in May for the first time in 11 months, dragged down by a sharp drop in receipts from auto dealerships. Total retail sales slipped 0.2 percent after a downwardly revised 0.3 percent increase in April. Economists polled by Reuters had forecast retail sales falling 0.4 percent from April's previously reported 0.5 percent rise. Excluding autos, retail sales rose 0.3 percent last month, the smallest gain since July, after rising 0.5 percent in April (Reuters Recap).
Did you read some form of overly encouraging news in that recap? I didn't even see mildly encouraging data. Stock investors seem to have focused on the slightly better than expected, but still poor "ex-auto" number and pinned weakness on high gasoline prices and supply chain disruptions from the earthquake and tsunami in Japan. Headline writers and talking heads leaned on this perspective to proclaim a new recession is not in the works, a view the Fed supports. Remember the Fed still sees the 1st half slowdown as "transitory". Their outlook calls for better growth in the 2nd half of the year.
I guess equity traders hung their hat on that outlook because the risk trade was "ON" for the rest of the day. Stocks never looked backed and bond yields were up up and away. The 10yr note closed a full point lower in price at 100-06, yielding 3.101% (+11.7bps). "Rate sheet influential" MBS coupon prices got crushed too. The Fannie Mae 4.0 MBS coupon went out -21/32 at 100-05. Reprices for the worse were reported, on multiple occasions. C30 rebate is looking a little light at 4.50% now.
That said, our bullish bond market bias took a shot in the mouth today. Sort of. Some signs of encouragement....
Stocks were desperate today after testing long-term support at 1270 yesterday. A breakdown of this important technical support level would be disastrous for equities as it would likely trigger the beginning of a capitualative sell-off. What we witnessed today was a desperate defense of 1270. S&P futures went out +1.4% at 1289.25.
Although "lift-off" level support was broken this morning, all is not lost in TSYs. The rally that took place following weak jobs data early in June...is still intact. Unfortunately if this sell-off carries over into tomorrow without a recovery attempt at some point in the day, we'll be ringing the alarm bells a bit louder.
3.09% was our sell-off target. We're pretty darn close to that point right now. Just above our target also happens to be the 200 day moving average at 3.10%
As previously mentioned, production MBS coupons got crushed today. In the chart below I've overlaid one of my favorite studies: Fibonacci Retracements. As you can see, the FNCL 4.0 has found support at a key technical level. I really don't have much to say about mortgages though. Valuations are very attractive as yield spreads are just off year to date wides....but we're still playing follow the leader with benchmarks. If TSYs weaken further, so will mortgage pricing.
BEWARE: You're on the verge of losing 4.50% quotes. Rebate is already looking very thin there...a continued down trade tomorrow would confirm an uptick in "Best Execution" quotes.
While 10yr note trading volume was indeed HUGE into the downtrade, we can't say this move was a surprise. In fact, if our big picture, "The Bond Market is Repeating History", point of view is as accurate as it was 6 months ago, today's sell-off was well-within the realm of expectations. These were the exact words we used on June 3rd: "Given the somewhat lower amplitude of the more recent stage (that would be the big grey square on the right, in case I've lost you), if history does indeed continue to repeat itself, then the suggestion is that we could see movement something like this...our first target is a 2.85% 10yr note yield. But first, NOTICE THE NEXT MOVE IN REPEATING HISTORY IS YIELDS MOVE HIGHER."
With today's sell-off, history certainly seems to be repeating itself a little more...
The bond market is not going to rally non-stop. There will be short-term reversals. It's normal behavior. It's healthy behavior. The past week has proven that point to be true. We're still feeling bullish, but we recognize the technical nature in which bonds trade, especially when they venture closer and closer to a duration ledge.