MBS Day Ahead: Absence of Data Leaves Bonds to Consider Their Fate

Good old 2015.  January was quite nice for fans of low rates.  The hotly anticipated ruling from the European Court of Justice on QE was about to be handed down and tradeflows were already benefiting from new position-taking in the new year.  Phrased another way, Treasuries had been more resistant to European influences into the end of 2014 and rushed to catch up as 2015 began.  This meant that US rates fell at an aggressive pace heading into February.

Treasuries led the first attempt to bounce in 2015 following January's jobs data (released at the beginning of February), but European bond markets held steady.  QE buying hadn't even started yet, after all.  When it did, there was an unexpected rush of liquidity and an unexpectedly lopsided buyer-to-seller ratio in European government bonds.  Treasuries got on board for one last push to low yields, but refused to go any lower than the epic 1.84 inflection point, no matter how hard Europe pushed. 

That was the beginning of what may be the end of the lowest rates in 2 years, and the lowest rates ever in Europe.  We don't know if it's THE end yet, but we're obviously meant to think so based on the moves in Europe.  We're also meant to see the changing of the guard between 2014's long, fairly linear downtrend in rates, and the unmistakeable uptrend that's taking shape in 2015. 

There's no data on tap for today, which leaves bond markets to contemplate this potential long-term fate.  In this environment, trading levels can either react to headlines or to themselves (i.e. trading decisions based on bonds hitting certain levels).  One zone of trading levels that's fairly likely to serve as a cue for "something" is the gap seen in the following chart:

When we see these sorts of gaps in any chart, and when the chart is close to filling the gap, we should pay careful attention to what happens next.  If yields get shut out here and move higher, it's a big vote in favor of the ongoing uptrend.  If they cross the gap and bounce back higher, it's bad if the move higher is a sharp one (signals that traders viewed the gap as a trigger to re-set short positions).  But if they cross the gap and don't freak out, it would mean we get to 'muddle through' at the very least, possibly better.