MBS RECAP: Bond Markets Invigorated by FOMC Minutes; MBS Outperform

There was a chance that much of the recent rally in bond markets had been due to the expectation that today's Fed Minutes would offer a softer side of what was seen as a 'hawkish' announcement back on Sep 17.  In other words, the idea was that markets took the actual announcement as bond-negative but figured the more detailed meeting minutes would sound a bit more bond-positive by comparison.  And that's exactly what's happened.

Because of that, there wasn't an immediate implication for a huge dose of new, strong momentum.  Markets "bought the rumor," so to speak, and the rumor turned out to be true.  As the afternoon progressed, however, bond markets went into snowball rally mode.  This occurs when some traders execute new bond purchases which in turn forces other traders who had previously sold bonds short to cover those losses by buying.  That buying further raises the price, forcing more short-covering, thus perpetuating the cycle.

Bottom line, markets did a good job of getting out ahead of this one.  At the end of the day, MBS saw the biggest benefit for 2 reasons.  First, MBS got the shorter end of the stick yesterday as Treasuries rallied more swiftly.  More importantly, because today's rally was a factor of Fed policy and because the central topic in Fed policy at the moment is the rate hike dynamic, the shortest maturities in Treasuries rally the best (because they're the closest to the most directly-affected short term rates).  For instance, 5yr yields dropped 7.7 bps today vs 10yr yields dropping only 2.3bps.  While 10yr Treasuries are still the best place to look for broad bond market trends, the implied duration for MBS is a bit shorter than 10 years, so when shorter duration Treasuries are outperforming, it can be help MBS perform a bit better than the 10yr.  This is normally too subtle to matter much, but today's variation in yield curve performance are much bigger than normal.