MBS Day Ahead: The Next Few Days Tell Us A Lot

Recent volatility isn't just the product of illiquid summertime trading against the backdrop of surprising announcements from global central banks.  Markets are definitely in the process of making big decisions.  At issue is the timing of the next downturn in the domestic economic cycle.  In other words, every so many years, stocks/bonds/growth/everything takes a dip together.  These dips usually correspond with recessions (but not always), and are marked by the lowest rates until the next cycle bottoms out.

In terms of timing, whether or not we're due for another cyclical swoon is a matter of great debate.  It can't really be known considering the unprecedented nature of financial crisis and its ensuing recovery.  There's no play book for this set of events.

If there was a playbook, it would probably make note of the fact that the last 4 cycles have bottomed out in 1993, 1998, 2003, and 2008.  There's a pattern there (3, 8, 3, 8).  Arguably, rates were at their lows again in 2013, but under very different circumstances than the previous cycles.  The 2013 trough was really just the afterglow of the 2012 bond market golden era.  Low yields didn't come about due to times being tough.  They came about due to endless Fed QE, shaky Europe, and absent inflation.

The question becomes: do we count 2012/2013 as another trough or ignore it due to its fundamental differences from other troughs?  If it doesn't count, the REAL trough (the one that's brought about by market forces, rather than Fed QE) would already be overdue.  Moving to that trough would look something like the orange dotted line with the #1 below (#'s 2 and 3 show alternate routes to the same trough).  Of course, it's not necessarily our destiny to end up in said trough, but there's no sane way to rule out the possibility.  In fact, with a Fed hike serving to make things generally harder for the economy, and with the lower 60% of income earners not spending that aggressively anyway, it's looking like more of a probability.

The consideration of such grandiose themes is behind recent volatility (don't even get me started on what the equities guys are considering).  This makes technical levels important in the short term.  They give us a framework to measure the progress toward, or away from our goals.   For now, the goal would be to generally hold the 2.14-ish zone in 10yr yields.  As you can see with past movements around that level, it's not an immovable line in the sand.  We'd just generally want to be seeing bonds doing a better job of pushing back lower once they're near these levels.  If we don't see that, we might have to pay some more dues before getting hopeful about another cyclical swoon.

At present, I'm more interested in how markets are trading based on tradeflows and trading levels as opposed to economic data.  Durable Goods at 8:30am can always be a market mover, but it could easily be overwhelmed in this environment, even if it's far from consensus.