MBS Day Ahead: How Much Pain Ahead for Bonds? Let's Ask 2013

In some ways and in some instances, past precedent can have some sort of predictive value.  9 times out of 10 though, it's only the sort of thing that comes up with the benefit of hindsight.  In other words, a guy like me might point out how history repeated itself and say "look how history repeated itself and predicted this move ahead of time." 

But instead, let's focus on something that past precedent is actually good for: serving as a reminder of how poorly (or well?) things can go.  If you recall 2013, you might remember the month of May being somewhat similar to the current time frame. 

Rates had been low and suddenly began lifting off at a seemingly inexplicable pace.  It took the broader civilized world until mid-June to realize what markets were coming to terms with as early as May 10th: the time had come for the Fed to begin backing down new asset purchases.  Cue the taper tantrum.

The sources of inspiration may have changed in 2015, but some of the movement is from the same playbook.  Whether we're concerned with a European yields having bottomed or an impending rate hike from the Fed, the same notion of an extra-broad shift  applies.  When markets first begin considering such shifts, counter-trends will eventually rise to challenge the prevailing trends. 

These counter-trends are often established and solidified with the sort of breakouts seen in the top section of the chart below (red and white circles).  Indeed it's this sort of breakout that has us now considering the broader counter-trend in the 2nd chart below.    But let's skip ahead and see if 2013 can suggest anything about how that tidy counter-trend COULD end up...

Again, there's no guarantee that a similar break higher is about to happen.  I don't even know if it's more likely than not.  The point is that it's absolutely a possibility, and in considering your personal strategy in the coming days and weeks, it's worth keeping in mind just how bad things can get.