The Day Ahead: Relatively Empty Calendar Increases Twilight Zone Potential

Imagine riding a bike, or an equivalent rote gross motor activity involving the navigation of a certain path.  In this example, we'll use the bike.  Now imagine riding this bike around a familiar path in a park.  The weather is clear--the temperature, ideal.  The pace is of your own choosing for the most part, though extra effort is required on some of the familiar hills.  You might have to occasionally adjust your trajectory for a passerby, another cyclist, or a kamikaze squirrel, but for the most part, this is a path you know, on a fair day, with a fairly predictable set of eventualities and possible reactions on your part.  Let this be "scenario 1."

Now for scenario 2, another dimension, a dimension not only of sight and sound but of mind.  Consider, if you will that you're every bit the cyclist you were in scenario 1, but the similarities end there.  The weather isn't necessarily bad, but it changes unpredictably.  You could be dressed for rain, only to be greeted with "86 degrees and sunny."  You could just have shed and stowed your rain gear only to be greeted with golf-ball sized hail falling sideways.  Don't bother with your suit of hail-proof armor because by the time you get it on there will probably be some freak lightning storm and you don't need to be any more metallic at the top of the next hill.

If you can manage to get started on your ride, you'll find the path very unfamiliar.  It might even change as you go with the hazards and obstacles popping up in surreal and insanely unexpected ways and at inopportune times.  Well, the kamikaze squirrel from scenario 1 was sort of surreal, but what if it was a jelly-fish?!  And what if you were operating a pedal powered submarine?  On the moon?  You see where this is going?  Actually, you can't see where scenario 2 is going, other than to expect that whatever's next will be non-sensical and potential maddening.

Such is the case with various stages of modern era fixed income trading in the United States.  Five years ago, if you'd suggested that Cyprus would have markets transfixed for over a week, and that an Italian comedian who wanted to abolish the EU was vying for a political mandate from an 87 year old President who only 2 years earlier had to appoint an unpopular technocrat after a wildly corrupt ex Prime Minister got a 4 year jail sentence, AND if you said that all of the above were the sorts of watershed events that would shape the long term trends of Benchmark interest rates in the US, you'd be laughed off the street (and if your mad ramblings were verbal, folks would have been liable to ask if you mean Cypress the tree). 

The moral of these stories is that there are some days and weeks where we get on the bike and nothing is like what it used to be.  Nothing is like what we were expecting, and at times, nothing is what it seems.  This past week spent with Cyprus has been one of those weeks.  Are there some basic ground rules of physics that probably apply even to the surreal fantasy world?  Yes.  In fact, a great many "if/then" likelihoods exist, not to mention that all the other stuff that normally moves markets is still having an effect.  It's just that it's woefully muted when juxtaposed with zany goings-on in the Mediterranean.

All that to say this: there is no significant scheduled economic data today.  That's terrifying if Cyprus or Italy manage to produce a sensational enough headline.  More terrifying would be if they produce TWO or more headlines suggesting different directions for domestic bond markets (MBS tend to really hate those back and forth head-fakes).  And of course, there's a perfect chance that there will as many or as few headlines as there will be and markets will be completely sideways--making it to the weekend to enjoy 2 days of looking forward to crazy-ville again next week.  

Between now and then, the risk to MBS is that Cyprus begins painting a clearer picture of how they might not precipitate a collapse of the Euro on Tuesday or that Italian President Napolitano has a seemingly bright idea to fix the current political issues preventing the formation of a government (yesterday he said he would make a statement today).  From a technical standpoint, Treasuries would look strong and stable if they manage to stay under 1.96.  MBS would get similar honors by staying over 102-22 in Fannie 3.0s.