MBS Week Ahead: Fewer Days, but Potentially Greater Significance

In several ways, last week was a bit of a let-down in terms of answering the big questions.  Treasuries and MBS had generally been holding sideways after suffering significant losses.  The worst was over in the wee hours of May 12th, and Treasury yields never went higher.  Unfortunately, the best was also over as yields never made it back to the previous lows from May 8th.  In fact, both at home and abroad, the most important bond market trading levels were generally making lower highs and higher lows.  In other words, the range was (and still is) consolidating.

In technical jargon, these sorts of consolidations are most often known as "triangles."  Taken in conjunction with a sharper preceding move, a triangle is frequently referred to as a "pennant" (where the preceding sharp move would be akin to the flag-pole), which is considered to be a continuation pattern.  In other words, whatever the security was doing during the 'flag-pole' time frame, it will continue to do after breaking out of the pennant.

That would obviously be bad in the current case, as the flagpole was established when yields were rising quickly beginning in late April.  But before you get too upset about this inevitability, it's good to remember that technical patterns like these are far from perfect predictors of the future.  In particular, this is the sort of pattern where we'd need to see a convincing break above the triangle before we assume the pattern will be completed.  I would personally be looking for a break and close above 2.30 in 10yr yields (teal line in the chart below) before saying that the pattern has taken the next step toward higher rates, but we should be on the lookout for any break of these upper lines as a preliminary warning.

There is just enough room left in the chart for markets to put off the decision until the beginning of June.  But as recently as last month, we have plenty of evidence to suggest that markets won't necessarily wait.  While it's true that next week's NFP data has the biggest potential impact, several of this week's offerings could get the ball rolling.

Whatever the case, data will be increasingly important.  That's the message from the past week where markets cared very little for what the Fed had to say.  The Fed's message has been received, and we're now simply assessing the economic data as a way to time the rate hike.  Mildly stronger data will solidify a September rate hike.  Weaker data might push the odds back to December. 

The impact from the domestic data will have to be balanced against the impact from European markets.  While the first major move in late April was clearly related to Europe, it's less clear that the next move will be.