MBS Day Ahead: Bonds at Risk of Confirming Death of Positive 2014 Trend

As Treasury yields and mortgage rates spiraled rapidly higher over the past two weeks, 2014's steady trend toward lower rates quickly strayed into vulnerable territory.  Specifically, 10yr yields lost more ground, more quickly than at any other time this year.  It's not just about the rapidity of the move, but also the distance from the central tendency.  In other words, if we draw a line that leaves an equal number of hourly closing yields above and below, it would be the central line in the following chart.  The circled area shows how Friday's yields broke farther away from that center line than any other weakness this year.

When we apply this sort of technical framework to rate movements, the initial break of a seemingly important line isn't as meaningful as an additional day spent above the line.  Even more reliable would be to wait for any obvious key events that may be on the horizon.  If the trend remains broken after those key events, it's all the more serious.

Fortunately, this week offers just such an 'obvious key event' in the form of Wednesday's FOMC events.  These include the policy announcement as well as the Fed members' economic projections and a press conference with Fed Chair Yellen.  Markets are already assuming that we'll get another installment of tapering.  There's almost universal agreement on that. 

The more contentious issue concerns the verbiage the Fed's been using to allude to future rate hikes.  Currently, the policy statement says the Fed will keep rates low for "a considerable time after the asset purchase program ends."  The recent speculation is that the "considerable time" phrase could be going away at this meeting. 

Not everyone agrees about that, but the more important issue is the broader notion that the Fed could do "something" to somehow accelerate the market's collective view on how much longer it should expect ultra-low policy rates.  Combine this with the chance that the economic projections show a migration toward shorter rate-hike time frames among Fed members and there's a recipe for a bit of a shock.  This is theoretically what the past two week's of bond market pain have been about.

As we've discussed several times over those two weeks, when a hypothesis is as widespread as this one, it doesn't really matter if it's true if so many people believe it's true. Because of that, we're likely to get a big reaction to this Wednesday's FOMC events regardless of the changes.  On a cautionary note, it's quite possible that the recent weakness has been happening for several other reasons.  As such, if the Fed happens to leave the "considerable time" verbiage unchanged, it by no means guarantees a healthy rally back to late August levels.