MBS MID-DAY: Strongest Gains Came Early, Now Fighting to Hold Them

It's been a nice, straightforward morning for bond markets.  Data was much weaker than expected and bonds rallied as a result. 

That said, it's not unfair to wonder why the rally isn't even bigger considering the size of the 'miss' in GDP (-2.9 vs -1.8 forecast) and in Durable Goods (-1.0 vs 0.0 forecast). 

There are three potential reasons.  First, bond market trading levels were already at the edge of the range before the data.  That means any further gains are pressing into new territory ("new" relative to the June 3rd - June 24th range).  If we consider that 3pm closing levels are the most important in suggesting a range break, market participants are still in the process of deciding if this is the data that justifies the break.

Second, GDP is backward looking (naturally, since it refers to Q1 which was January-March).  Some discount this period due to the weather impact, but there are also considerations surrounding inventory fluctuations and Affordable Care Act accounting.  Beyond all that, the lower Q1 is, the higher Q2 becomes, all things being equal. 

Finally, Durable Goods is a fairly cyclical report.  That's not to say that a big miss doesn't matter, but the headline isn't the full story.  Much like there are reports on inflation with markets tending to care more about "core inflation," there is also a core component of Durable Goods (though it's not called that).  The "Nondefense, excluding aircraft" component is effectively the core reading for Durable Goods and it was +0.7 vs +0.5 forecast--much more palatable. 

All told, the rally makes sense, and the hesitation to take it any further makes sense as well.  10yr yields are fighting to stay under 2.545.  They've been doing a good job so far, but there have been a lot of tests/bounces.  Fannie 3.5s are underperforming, but still roughly a quarter point up, fighting to hold 102-20.