MBS Week Ahead: Getting Closer to Decision Time for Bond Markets

A common quip on Wall Street is that financial markets will do what it takes to prove as many people wrong as possible.  Variations of the same concept include the "pain trade" as well as the seminal quote from Keynes regarding markets' ability to stay irrational longer than you can remain solvent.  The underlying truth in these ideas is that there are no crystal balls and markets are efficient when it comes to punishing 'obvious' choices.

Interest rates were 'obviously' going to go higher in 2014.  When they instead began heading lower, the so-called pain trade ensued.  The lower rates went, the more traders had to make the painful decision decision to switch their stance or face potentially greater pain in the future.

Whereas the consensus on the direction of rates was pervasive heading into the year, it's finally getting more balanced now.  Analysts, trader commentaries, pundits, and mavens are increasingly seen calling for lower rates--so much so that we can now wonder whether or not the pain trade might soon repeat itself in the opposite direction.  In other words, is the bandwagon for lower rates now too much of an obvious choice or does the April/May rally have more room to run?

One of the keystones in that debate is next week's European Central Bank policy announcement.  We're basically waiting to see which of the policy rates are cut, by how much, and whether or not there will be some form of quantitative easing.  With Nonfarm Payrolls arriving the next morning, it's an important 2-day stretch for a domestic bond market that's currently very close to a long-term inflection point (2.47 in 10yr yields).

The past 2 weeks have acted as a correction/consolidation after bouncing on that inflection point.  As far as these sorts of consolidative movements go, this one could be over soon.  Naturally, next week seems like the best candidate for either a bigger bounce higher in rate or an exploratory mission to the best levels of the year.  But it's not uncommon for bond markets to 'lead-off' in either direction.

In the chart above, the white lines represent the current rate rally.  This range leaves room to move around quite a bit this week without making any big decisions (a big decision would be a break below 2.47, or a move back above the white-line channel).

If we see much of a response to economic data, Today and Thursday are the best bets this week.  Durable Goods and Consumer Confidence are today's most relevant reports, with GDP being the focus on Thursday.  Friday is also made more relevant because it's the last day of the month, which can see extra trading activity for a variety of reasons.