MBS RECAP: Bond Market Meltdown Resumes; Big and Scary

As I check my mental inventory of recent headline titles, I find it interesting and scary that the only other times that compare historically have been the BIG moves like the mid-2013 taper tantrum.   The difference is that the taper tantrum was one big, logical thing.  Markets came to terms with what was going on in May and June, and quickly set about pricing Fed bond buying out of the equation.  It was fairly tidy in retrospect.

The current move is more of a perfect storm of disparate factors.  At the heart of that storm, clearly, is an ongoing correction in European bond markets.  Rates in Europe had moved relentlessly lower throughout 2014 and the first part of 2015 as investors accounted for the likely effects of ECB Quantitative Easing.  For the past three weeks, European rates have been spiking at a break-neck pace.  It's an aggressive enough move to suggest traders are entertaining the possibility that the global rate rally has bottomed out for now.  I say "entertaining the possibility" because if they were sure, 10yr Treasuries would be closer to 3.0% (If that sounds crazy to you, consider that we were at 1.90 just two weeks ago and are now up to 2.29!).

Other ingredients in this storm add to uncertainty.  The tradeflow story is big.  If everyone was essentially on the same page about the long term EU-QE rally, there have been an awful lot of bullish bond market bets to unwind.  You might hear this referred to as a pain trade or capitulation.  By any name, it is the chief ingredient in snowball selling where a change in price based on one trade triggers another trade, which in turn changes the price and triggers another. 

Tradeflow momentum has clearly been exacerbated this week by supply concerns.  Normally when we talk about supply it's with respect to Treasury auctions or new MBS issuance.  But corporate bonds have increasingly stolen the spotlight there.  Corporate issuance has been unabashedly huge.  2015 is on a record pace following 2014's record.  Today alone saw over $10bln in issuance.  Not only does this add supply to the bond marketplace, but it does at least 2 other bad things.  1st: it raises concerns that more companies will rush to issue debt before rates keep going up.  2nd: the issuance process itself often relies Treasuries being sold as part of the hedging process, thus adding insult (an immediate negative tradeflow used in the rate-lock process) to injury (the anticipated negative tradeflows from investors selling Treasuries in order to purchase the new corporate debt).

On top of all that, there's the constant ebb and flow of Fed rate hike expectations.  This is actually not the first thing on the bond market's mind for once, but it does have an effect.

It's a serious sell-off that could get much worse and even put out head-fakes as if it will get better.  It should be taken seriously until/unless it's clearly defeated.  To be sure, we're not there yet.