MBS RECAP: Bond Markets Start Strong, but Slide into Negative Territory

Overnight trading was positive for bond markets with 10yr yields falling to 2.319 as they crossed into the domestic session.  Slumping stocks and European bond yields led the charge.  As the European close approached, the tone shifted toward weakness for bonds and strength for stocks.  This was doubly compounded for Treasuries, both by the approaching 10yr Auction and another heavy day of corporate debt issuance.

Why are those two factors negative for bond markets?  As far as the auction is concerned, the trading community essentially "makes room" for new bond issuance by trading current securities lower in price.  There's no hard and fast formula for this, but the point is that it's not uncommon to see some additional weakness ahead of auctions.  Market participants are not only making room to buy new debt, but also ensuring less volatility by trying to trade the expected auction result in advance.

Corporate debt issuance hurts us on two fronts as well.  There's a similar aspect of "making room" as some investors have the ability to buy corporate debt instead of Treasuries.  The more insidious problem concerns the mechanics of the issuance process itself.  When companies announce the bond offerings, they can effectively "lock in" their financing costs by selling Treasuries (because Treasuries are frequently the basis for their bond pricing, e.g. Big Company A is offering 10yr  notes at US Treasury 10yr yield + an 80bp margin). 

The double whammy met a surprisingly fertile environment today in terms of a LACK of widespread market participation.  It made more sense that Monday would have been fairly quiet in terms of volume and liquidity, but today was nearly as bad.  This, by no means, makes the price movement any less relevant.  It simply amplifies whatever bias existed.  Today, that bias was negative from 11am on.

The silver lining is that there as enough positivity in the morning that MBS are only a few ticks in the red here at the end of the day, and Treasuries are still inside last week's ranges.  The not so silver lining is that these levels are a much more precarious place to be in light of the hope that Friday marked a turning point in the recent selling spree.  In other words, if we get much weaker, we'll no longer be holding ground.