MBS Day Ahead: Busiest Day of Economic Data Presents Good Opportunity

Today is by far and away the busiest day of economic data this week.  This presents a good opportunity to feel out what's important to the bond market.  Here are a few of the current contenders:

1. Economic data
2. European Central Bank policy shift expected in early June
3. Geopolitical Risk Surrounding Ukraine
4. "New" justifications for an impending bond market rally (these tend to center on one of several sub-topics including)
   1. aging boomer population shifting investments to longer-maturity bond market.  more...
   2. pension funds suddenly realizing they want to buy a lot of 30yr bonds and there are none. more...
   3. 2013 taper-induced move to higher rates was somehow 'overdone,' and now is due to come back in the other direction

Economic Data

The Retail Sales data at the beginning of the week is a clear enough suggestion that bond markets are interested enough in reacting to economic data.  At least that's an easy, logical, superficial takeaway.  But contrarians from the other market-moving bullet points in our list might as easily say that the true motivation for the movement was from their camp and Retail Sales just provided a convenient excuse.  After all, bond markets rallied after a strong NFP earlier this month--they'd argue--because bond markets wanted to rally for other reasons.

European Policy Shift

This is clearly a market-mover, and it is so broad-based that it can't be as easily refuted as the economic data "convenient excuse" mentioned above. Take a look at German 10yr debt leading US 10yr Treasuries lower over the past two days.

The only problem with this is that the promise of European Central Bank easing is something that markets have responded to on many occasions only to find that reality was less sensational than the hype.  Then there's the question of how much it has already been traded.  When US and German debt have gotten far enough apart, markets have essentially forced Treasuries to keep pace with Bunds if the latter continues trying to move lower.  This has happened recently in mid-April, late April, and over the past two days.  The chart below is the US 10yr yield minus the German 10yr yield.  The higher it is, the lower Germany is compared to the US.  The yellow horizontal line is that 'sticking' point where Treasuries say enough is enough.  You can bet that traders are cognizant of the precedent from 2005-2006 in determining how wide to let this spread get.

What's the implication here?  Quite simply, if German yields continue to fall, Treasuries are likely to follow.  This played into Tuesday and Wednesday's rallies heavily.

Geopolitical Risk

If anything is a convenient excuse for markets to do what they were already going to do anyway, this is it.  It's not that the situation in Ukraine hasn't had an effect on financial markets, just that it's a marriage of convenience.  It's been amazing to see the Ukraine-related headlines that get credited for market movement while other, seemingly more serious headlines produce no result.  This can't be counted on as a consistent market mover, but neither can it be counted out as a potential consideration.

The New Justifications

I've said it before and will say again, by the time these concepts make it into articles in major media outlets, they're no longer "news" to the trading community.  It's not that pension funds and managed retirement funds don't have an effect, but when you look at the breakdown of major holders of US Treasuries, this suddenly seems like less of a surefire recipe for a massive rate rally (hint: Pension Funds are the small orange piece of pie near the middle of all the other small pieces of pie that are completely dwarfed by foreign holdings and the Fed).

source: Global Macro Monitor

If there's a thesis here, it's to be skeptical about easy answers. The only easy answer possible for today would be if the economic data is broadly stronger and rates move higher.  If that happens, we'll have some measure of confirmation that the data matters at the moment.  There are important reports in all time slots, though the stand-outs are Jobless Claims and Philly Fed at 8:30am and 10am respectively.  Other data is perfectly capable of eliciting a response however, and there's a lot of it.