MBS Day Ahead: Blame Game and the Road Ahead

One blessing and curse associated with being human is our innate desire to make sense of the world around us.  Yesterday's bond market rally was--in many ways--nonsensical, yet that only makes the drive to understand it--to dissect it--that much stronger.  In other words, we need to blame stuff on other stuff.  And when that stuff is super interesting/happy/painful/intense/uncommon, our desire to blame is that much more intense.

But let's give these defendants due process before we simply assume that my lead suspect (i.e. "bond markets taking advantage of a major stock market correction") is guilty.  Granted, some of these are interrelated, but I just wanted to offer a few other ways to look at it.

1. Stocks!

Of course you're already familiar with this line of thinking.  Stocks sell, bonds rally.  This isn't universally true and it's especially not true over longer time horizons (after all, stocks were tiny in the 80's when bond yields were immense), but it's almost always true over short time horizons during big moves.  The most notable historical exception was the "QE-on vs QE-off" trading days of 2012/2013 where QE was perceived to be good for both stocks and bonds.  The bottom line here is that any time during the recently bullet-proof stock market rally where a correction looked to be possible, bond markets were almost always there, making periodic lows in yield at the same time as stock swoons.  Click the chart to make it bigger:

2. Europe! 

(my apologies if this is your first time reading this commentary.  Otherwise, you're well-acquainted with European markets and German Bunds as steadfast traveling companions to US bond markets).

3. The Fed! 

We've talked a bit about the most recent FOMC Announcement and more importantly about the most recent FOMC Minutes.  The theory goes that the Fed Minutes were a lot more dovish than markets perceived the Announcement to be weeks earlier.  In fact, I flat out declared that bond markets were "invigorated by the FOMC Minutes," and they were!  But how can we quantify that, prove it, and tie it in to yesterday's big move?  How about this chart of November 2015 Fed Funds Futures?  It basically shows the Fed Funds Rate expectations going from .65 to .3 in the space of a few days.  Keep in mind that with a target range of 0-.25 that a 0.3 Fed Funds Rate means a lot of votes for "no hike until 2016."  Unsurprisingly then, June 2016 was one of the most active futures contracts yesterday.

4. Ebola

Could this really be a thing for markets?  Yes.  No one really knows how big a thing, but it's certainly not helping the global growth outlook.  If you're into conspiracies, you might even wonder if the virulence hasn't been downplayed due to the potential impact on the economy.  That might sound crazy, but how many people do you personally know who would get on a plane for business if it turns out that anyone on this plane happens to contract the disease?

5. Economic Data

This hasn't moved markets much recently, but that's because bonds have been rallying and data has been pretty good.  Now that we got the bad Retail Sales data from yesterday, we saw more of a willingness to trade that data because it fell in line with how bond markets were already predisposed to trade.  Convenient reality.

Put 'em together and whaddaya got?

GLOBAL GROWTH CONCERNS!

(and that's why I find myself to be a surprisingly big fan of this stupidly cliche mass media catchphrase.  Drink the kool-aid.  Everybody's doing it, but in this case, they're all right).