MBS Day Ahead: 2015's Higher Rate Rhetoric Beginning to Unravel

Most of this morning's day ahead was written in a speculative manner on July 24th HERE.  On that day, I closed with:

Despite all the Fed rhetoric on rate hike intentions, despite things like the lowest Jobless Claims since '73, despite the broadest expansion in payrolls since the late 90's (just never you mind that it followed the sharpest contraction in payrolls since WW2), there is still a scenario where it could make sense for rates to fall. All that having been said, it's just something to keep an eye on until and unless we make more meaningful headway.

We've now made more meaningful headway.  The most recent catalyst has been China--namely, the government's efforts to weaken the currency.  This was accomplished simply by removing the "peg" to the US dollar.  In other words, China's central bank set exchange rates every day and allowed a certain amount of movement on either side of the peg, before starting it all over again the next day at or near the previous pegged rate. 

With the peg removed, China's currency (Yuan or Renminbi, depending on how much of an FX snob you want to sound like) will open each day where it ended yesterday.  So what had been a 2% loss over an indefinite number of days can now be a 2% loss every day.  Chinese currency trading had been like Groundhog Day, and now it's real life.

So far, things aren't going so well in real life, and the currency has fallen 2% for the past 2 days (with most of the losses coming early).  The weakness is what China wanted, but it sends a troubling message to the rest of the world.  It actually sends a few messages.  Here are some of the things it might say:

"Hey everyone...  Things are THIS bad in China that we have to do this... " 

"Here!  have some deflation, world!"  

"Oh what's that other export-driven economies?  You wanted to grow and compete?  Tough luck."

"Oh hey Fed... You wanted to hike rates?  You still want to hike with your runaway dollar strength crippling multi-national companies' profits?"

"Hey folks, the currency war is on!  First one to the bottom wins."

Whatever the case may be, it looks like this snowball is now officially rolling on that thesis "what if it's all not enough?"  When stocks and bond yields are falling together, you know it's not Fed rate-hike-related.  People are legitimately freaked out about the possibility that we're on the doorstep of the next economic cycle (i.e. the big dips in stocks, bond yields, and growth that tended to show up roughly every 5 years until the QE era disrupted the natural flow).