MBS RECAP: Bond Markets Relatively Blindsided by Snowball Sell-Off

It began as just another day in a 12-day winning streak for bond markets that had seen 10yr yields recover 40bps peak to trough.  Actually, "just another day" doesn't really apply to that scenario.  We're lucky to see it happen a few times a year.  That fact alone is enough to justify the modest 5bps pull-back we saw today (or 3/8ths of a point in terms of MBS). 

Still, it seemed to come out of nowhere in the context of the recent trend.  But there are a few ways to make sense of it beyond the opening paragraph above.  First of all, any time S&P futures fall 30 points over the course of the session, something is up.  In this case, the stock weakness not only coincided with bond market weakness in a general sense, but they also kicked in to gear around the same time of day.  We've now just gone from "something is up" to "hot clue."

There are only so many reasons for stocks and bonds move in unison over the short term.  In recent years, the most common reason has been what some refer to as the "QE on/off" trade.  This time around, it's not so much about quantitative easing as it is about the general concept of "accommodation," but the principle is the same.  Simply put, the more accommodation markets get from the Fed, the more reason they have to rally--both stocks and bonds. 

This "accommodation on/off" trade was ridiculously apparent during the 2013 taper tantrum, and I just referenced it again this morning!  I thought it was odd that stocks and bond yields had reconnected yesterday after having done the accommodation shuffle in recent weeks as markets considered Fed rate-hike potential.  As it turns out, markets thought it a bit odd as well, because they were right back to the same song and dance today. 

Given the glaringly obvious phenomenon of stocks and bonds selling off together, one need only look at the inception of the selling and the news available at the time for possible clues.  In today's case, one clear candidate jumped out.  The moves began not long after this article began making rounds on newswires. 

Long story short, Atlanta Fed President Lockhart (a very pragmatic sort of guy who tends to forgo some of the personal biases that cloud other Fed comments) said it was likely that the committee would vote to raise rates by September.  If you click through and read the article itself, you'll see that it wasn't said in nearly so sinister a way, but the newswires definitely didn't capture that same level of balance and indecision.  Thus, markets were left with the notion that a rate hike is still very much on the table in spite of the dovish reading of Yellen's press conference and last week's FOMC Announcement. 

Even before the Lockhart news, the first clue that the day might go poorly came after a terrible Durable Goods report did nothing to help bonds extend their rally.  Lockhart wires consequently hit an already exhausted bond market, and it was easy selling from there.  A relatively awful 5yr auction and an uptick in corporate bond issuance added insult to injury over the course of the day.  Frankly, considering all that, the losses don't seem that bad, but they're bad enough to shift to a more defensive stance for the time being.