The Day Ahead: Bond Bulls Muster At The Gate

Thinking about bond market trading levels in the context of "battle" is fun.  Analogies make technical concepts easier.  So here's a brief battle analogy for what might be going on technically at the moment. 

As a point of order, please note that MBS can be used for long term technical analysis, but are inferior to Treasuries when it comes to assessing trends that include things such as 5yr moving averages.  We're not concerned with intraday reprice risk here, or even shifting dynamics in spreads between MBS and Treasuries--merely in the general bullishness or bearishness of  longer-duration bond markets.  10's are the best for that, even though this is an MBS site.  On to the analogy.

There are two prominent lines that have acted as "then and now" separators for 10s during the main leg of the recent sell-off.  That sell-off is the trading taking place after the JUNE FOMC Announcement and falls inside the yellow railroad tracks below ("trend channel").  The lines of demarcation are the 5yr moving average (which has appeared in several charts over the past few months) and the 2.747 yield.  It doesn't have to be exactly 2.747 for any special reason, but it's close. 

The trend channel is like the current morale, tenacity, and vigor of our 10yr yield fighting force.  The closer they are to the lower line, the harder they're fighting, even if they're losing the battle overall, but run the risk of getting tired.  The closer they've been to the upper yellow line, the more their backs are against the wall. 

The orange and teal lines are simple two ways to look at mid-point of the battlefield, or the castle walls, if you will.  For the purposes of the analogy, I suppose that means we'll have to consider Treasuries as having once had a home inside the castle and having been quickly carried to the gate, beaten a bit, and pitched over the side in mid August.  But since getting the boot, they've been trying to get back in.

After storming the castle once--unsuccessfully--Treasuries regrouped, played it close to the hip in early September, and waited for the perfect opportunity to revisit the castle walls.  This occurred during Wednesday's FOMC rally but they've been very careful not to knock too many bricks out of place.  We can consider that they're facing resistance at the wall, or simply that they're mustering and preparing for an assault that's more likely to be successful this time, because they know they'll have to push the limits of their morale and tenacity (remember the trend channel) if they're to break meaningfully lower.

The biggest risk to this outlook is how obvious it seems.  Yes, of course the long-term default assumption should be that rates will gradually be rising as long as economic data is gradually improving, but that doesn't mean we can't experience at least a somewhat-meaningful adjustment in the pace of that longer term move, courtesy of the Fed's abstention from tapering.  The post FOMC rally was a measured move!  It was arguably more of a sea-change in the reality of monetary policy than markets gave it credit for in response.  That makes yesterday seem like a consolidation and the upcoming two weeks seem like a chance to rally through next week's auction process and into month end before circling the wagons for NFP in the following week.  10's could easily push 2.55 in that scenario. 

Again, the biggest problem with that scenario is how easy it is to argue.  In other words, if an outcome in financial markets looks too likely, it usually isn't.  It's unclear whether or not today helps flesh out this battle or if the troops will bide their time.  We have FOUR Fed speakers and will thus get to see if anyone cares about anything they have to say or if we have our "fool me once" earmuffs on.  In addition to that, today is the expiration for several futures and options contracts ("quadruple witching"), which can make for volatility and seemingly random buy/sell momentum as positions are closed and swapped.