The Day Ahead: MBS in Full Melt-Down Mode. What Next?

The idea of "tapering" the Fed's long term asset purchases isn't as new as the past two weeks might make it seem.  It was most visibly introduced in early February when both Bullard and Fisher spoke out in favor of the notion.  But a quick count of all Reuters newswires in which the word has appeared since then shows that it really exploded on April 10th after the last FOMC Minutes release.  Suddenly, "tapering" was the talk of the town and was strangely soothing to bond bulls fearing a more abrupt exit and strangely emboldening to Fed Hawks, seen as proponents of immediate tapering.

Then a month of relative excellence for bond markets caused amnesia on tapering topics and the new FOMC Announcement on 5/1 even left the door open INCREASED asset purchases.  In the midst of a raft of mostly negative economic data and the prospect that 5/3's NFP would confirm it all, bond markets were out to maximum-distance lead off, testing the validity of longer term trends.  All it took was the catastrophically positive Jobs report, and headlines like this were mere hours away:

RTRS- POLL-15 OF 15 DEALERS SEE FED TAPERING THE SIZE OF ASSET PURCHASES BEFORE TERMINATING LATEST PURCHASE PROGRAM 

So we had point/counterpoint on tapering.  On the one hand, it was "in" as the frontrunner for HOW the Fed would eventually back out of asset purchases, but the WHEN was very much in question.  Speculation about "the WHEN" grew rampant on Thursday and Friday May 9th and 10th with the latter marking the awkwardly and ambiguously written Hilsenrath tweet and eventual article that said the Fed is Mapping an exit.

Problem with that conspiracy theory is that bond markets were already selling off on Friday after Bernanke not only mentioned concern that markets were "reaching for yield" but also failed to deliver any soundbytes that would pump up prices on the bonds that dealers just acquired over the past two days--something they'd sort of been waiting on him to do--thus leaving them with a decent chunk of inventory to get rid of in a hurry.  Friday's sell-off ensued.  Markets thought it had to do with taper-talk.  Hilsenrath's article came out Friday night, markets gapped weaker on Monday and tapering was suddenly cemented as the the flavor of the month.  Paranoia duked it out with fundamentally logical "yeah buts" and largely won.  The net effect on MBS has been a sell-off in an increasingly volatile range: 

The fact that we've gone from "tapering" having been relatively forgotten heading into the month of May to the Fed Chairman himself saying that it could begin in the next few meetings is a big deal.  The whole thing reeks of conspiracy theory in the most legitimate way we've seen in a while.  In this case the conspiracy is that 5/3 Jobs report was a trigger event that caused a bit of panic among Fed governors to sell the idea of Tapering as quickly as possible so that if the next jobs report justified it, markets would a whole lot less shocked when the asset purchases they thought would be consistent through most of 2013, suddenly started losing passengers as early as the June meeting.  It was a herculean effort to engender that much defensiveness that quickly.  Most every Fed speech was part of the show and Hilsenrath worked his script to the best of his abilities as well, but here we are on 5/23, having just cracked 2.0% in 10yr yields without much of a change in the economic data.  This isn't all follow-through from 5/3's jobs report, but either a material commitment to the longer-term uptrend in rates (and admission that late April was indeed an overstretched "lead-off") or the surprisingly fast acceptance of the notion that several billion dollars of asset purchases will be missing from the next FOMC Statement.