MBS Day Ahead: Big Picture Considerations for a Data-Free Friday

Yesterday's session was too close to call as far as being a positive or negative epilogue to Wednesday's FOMC day.  While it's always positive to not be losing ground in a convincing way, it's pretty negative to be convincingly holding ground when the last 3 weeks have seen almost nothing but weakness.  In other words, yesterday went a long way toward solidifying current levels as something more than a temporary diversion from recent low rates.

MBS charts speak to this phenomenon even better than Treasuries.  Typically, 10yr Treasuries make for the best technical analysis of trends in mortgage rates even though rates are ultimately dictated by MBS (due to volume, liquidity, futures markets, and not being affected by "the roll" in the same way).  This time around, however, we can plainly see the recent spat of low, stable rates in the tightly clustered trading of the past 3 months.  The big gap that follows is partly fueled by the roll, but would not be quite so stark were it not for the organic bond market weakness in September.

As far as that organic bond market weakness is concerned, let's take a look at 5yr Treasuries.  We don't normally follow 5's because, frankly, 10's are better for our purposes in almost every way.   But drama in the 5yr sector is spilling through to the rest of the bond market.   Market participants have been unanimous in their distaste for 5's of late, and in many ways, they're leading this rate sell-off as far as Treasuries are concerned.

In more ways than one, 5's are caught in the middle.  They've gleaned some of the benefits afforded to shorter duration Treasuries in that they were better able to endure the tapering-related sell-off of 2013.  After all, the rate hike discussion wasn't the main attraction back then.  So 2yr Treasuries were doing great and 5's were close enough to 2's to stay somewhat insulated.  For those same reasons, 5's had rallied harder and remained lower during the QE era.  But now that the rate-hike discussion is front and center, it's a double whammy for 5's.  Not only did they look overvalued compared to other Treasuries, but it is/was now becoming time for the parts of the yield that had benefited from the low-rate pledge to panic.

Incidentally, 5yr Treasuries did the same thing during the sell-off of the mid 2000's.  If history is any consolation, 10's managed to hold relatively steadier while 5's couldn't catch a break for 3 years.  But then again, if we're on a similar historical path, we're waiting for 5's to work their way up to 10's territory while 10's drift gradually higher. 

The genuinely good news is that either Europe will save us with their crappy economy, or we'll sooner be able to see the inability of our domestic economy to support rates much higher than they are now.  The first part of that wouldn't be very fun, but it would only be temporary--just like it was in late 2013/early 2014.