The Day Ahead: Waiting for the Next Line to be Delivered

If bond market trading were a movie script, we're at that point just after "the girl" yells at "the guy."  In the romantic comedies with the happy endings, this would be the "darkest before the dawn" moment--perhaps cutting away to a montage of "the guy" walking alone on a rainy night, thinking about how he screwed things up.  But we're not quite to the montage yet.  

In this script, we're still at the part where "the guy" hasn't responded yet and "the girl" is growing increasingly put off by that fact.  Any moment now, she'll deliver the cliche: "Well?  Say something... Anything!!!"  

Sometimes the tension eases after that part in the movie, but only if leads to a breakthrough right then and there (example: the guy fires back: "that other girl you saw me having coffee with is actually a custom jewelry designer who just finished making this ring... will you marry me?" and cue the happy ending).  But more often than not, it's a set up for a the rainy, walky montage thing.   

Let's mix a bit of reality into the metaphor now..  Let the white line below reprebsent the depth of the love that our two cinematic lovebirds feel for each other.  Note the infatuation stage in early April!  After settling in to a groove mid-month, things got serious into the beginning of May and then "the yell" happened last Friday.  

If the heading on the chart didn't make it clear, the white line was actually more than just the metaphorical love index in movie.  It might as well be though--at least for our main actor MBS.  Reason being: if 10's were keen to hold that steady zone around 1.68, MBS would be completely in love.  

Such levels--stably held--would keep grease on the skids of the "down in coupon" trade, helping Fannie 3.0s continue to dominate (and helping 2.5 coupons to take maybe 7-10% of the 30yr Fixed Conventional MBS originations as opposed to the 1-4% they've taken over the past few weeks).  

But MBS don't care for this unresolved conflict one bit!  They were on board with the way things were heading since mid-March, but have quickly jumped off (staying above and then breaking the diagonal yellow line in the chart below).  

It would take one of those movie miracles to get MBS back above the diagonal trendline.  Such things can happen, but the more likely reality at this point is to assess which side of the horizontal line we'll favor over the next few weeks.  Historically, 3.0's don't like to move back and forth through that zone much--preferring either to bounce or break convincingly (mid 2011 could be seen as an exception for several reasons).  You could say that somewhere near 104-00 (give or take a few ticks) is where MBS prefer to sit when they're waiting for the next line to be delivered.