MBS MID-DAY: Bond Markets Weaker; Pressure from Europe and Auctions

This morning's first update on MBS Live noted that despite overnight press crediting China for prompting bond market weakness, it was in fact European markets that dragged Treasuries toward weaker levels.  The primary culprit was an inflation report from the Bank of England (their version of the Fed).  Although inflation was tame, markets responded instead to the fact that the BOE did nothing to address disinflation. 

In other words, some market participants expect central banks to use accommodative monetary policy to aggressively combat deflation.  This is generally in line with rates being or moving lower.  When the BOE didn't give markets the hints of accommodation, rates moved higher--led, of course, by UK rates. 

From there, there's a domino effect with diminishing correlation running all the way to MBS.  German Bunds were affected almost as much, US Treasuries next, and MBS the least.  The following chart should leave no doubt as to the domino effect (note German Bunds pushed the pace later in the morning, but this was due to a technical break.  The most important features of the chart are the instances where the European debt is bouncing at the same time as Treasuries).

Beyond Europe, Treasuries must also be somewhat concerned with the upcoming auction as it represents extra supply for bond markets to purchase.  Rates can rise in advance of that supply in order to facilitate a smoother auction process (aka a "concession").  As such, it's possible to see relief after 1pm even if the auction is in line with expectations, though this happens more often when the week's auctions conclude on Thursday afternoon.