MBS Day Ahead: First Significant Data of the Week; Last Treasury Auction; Hungry Rally

Bond markets seemingly rallied rather impressively yesterday.  In other words, the magnitude of the gains and levels achieved would have been impressive if they'd happened in a vacuum where bond market trading was the only game in town.  As it stands, there were other games in town, and they happened to be rather intense.  These include:

• one of the weakest days of the year for stocks, with the S&P dropping more than 30 points
• new 6-year lows in oil
• new all-time lows in German (aka "Eurozone") bond yields
• new all-time low in Japanese bond yields

The list could likely be expanded with other trivia, but the point is made.  It wasn't just another day for global financial markets.  It hasn't been just another week, month, or year either.  We may be witnessing an overly-insulated US-centric point of view standing on the brink of that realization.

Why, again, were rates supposed to go higher in 2014?  Actually, those answers made sense until April, when the ECB's QE discussions came to light, but since then, have US markets done nearly enough to catch up with the rest of the global panic?  A few smart traders know the answer, and they've been using that knowledge to take money from everyone else who repeatedly thinks "OK, NOW is the time that yields have bottomed out and will inevitably head back up."

It's not that anyone should expect US bond markets to be wallowing in the mud to anywhere near the extent of the countries and financial instruments in the epicenter of the blast.  US 10s have no business being at 0.7 percent, like German 10s.  But maybe US markets haven't done enough to appreciate the gravity of the situation.  Europe is going down until it's not any more. 

It's almost unfathomable to consider that  a big corner has been turned yet.  It will only get fathomable when the red line on the chart above gains back about half the ground it lost in 2014.  Unfortunately, domestic rates could experience a lot of volatility between here and there in such a case, but the tradeoff is that we get mortgage rates in the high 3's again.

The other tradeoff is that this is "hungry" rally.  It requires a constant diet of global turmoil and panic.  Whenever it looks like Europe isn't making new progress in its death spiral, US bond markets start wondering about that long-term corner being turned.  Even on shorter time scales, US bond markets looked ready to weaken yesterday, had it not been for the laundry list of big, bad things above. 

Rest-assured, US bond markets are ready to weaken again today if they're not fed another impressive meal.  Today's menu has added flavor from economic data.  The only thing that really matters here is Retail Sales at 8:30am.  It's not enough to counteract any major movement overseas, but if it happens to suggest the same movement as overseas data, things could start moving very quickly indeed.

The only other loose end to tie up is the last Treasury auction of the week.  Yesterday's 10yr auction proved to be a positive turning point, but a word of caution there: it was really more about stocks in the afternoon.  In other words, don't expect any heroics from the passing of the 30yr auction if other markets are arguing loudly against it.