MBS Day Ahead: Time For Bonds to Choose Their Own Adventure

Earlier this week, bond markets came to a fork in the road.  There are two options for the next chapter in the current adventure.  While neither is likely to drastically change the conclusion of this book, one of them would make things more enjoyable in the near term.

Behind door number one, we have the reality where bond markets are already seeing a solid level of sponsorship kick in with 10yr yields in the mid 2.3's.  It's a bit lower than I would have thought to see a strong showing of opportunistic buyers getting back into owning Treasuries after the recent rout, but tradeflows and technicals have arguably made a case for it.

Behind door number 2, we have the reality where yesterday was a bond market holiday and where the shifts in technicals seen in the chart above were merely the byproduct of a "short base" moving to cash ahead of the day off.  Confusing sentence there, so let's break it down.

A "short base" simply means that there is a big group of traders betting on rates moving higher (aka "shorting bonds").  We know there is indeed a big short base due to several surveys and reports that--taken together--do a pretty good job of letting us know how traders are positioned.  If a trader who is shorting bonds "moves to cash," that's just another way to say "buying bonds."  Reason being: a short position is closed by buying the security that was sold short.  So if I'm betting on rates moving higher, I sell bonds short, and I get my cash by BUYING in the future. 

To recap door number 2, the recent positive shift in technicals could simply be that short base buying bonds in order to close their positions ahead of the holiday.   Being ready for anything around current levels makes sense.  10yr yields around 2.34% definitely have a history of being an important big-picture inflection point.

Today's trading may or may not give us the satisfyingly clear decision we'd like, but it ultimately shouldn't affect the longer term trajectory in rates.  If you had to describe this, you could say that there's "muted pressure toward higher rates that should continue to receive periodic wake-up calls from the shaky global economy."

As far as specific events, there are a TON of Fed speakers hitting the wires today, including Yellen herself at 930am.  The only thing any of them could do that would be the slightest bit interesting would be to completely diverge from essentially all the recent communication and start arguing against a rate hike.  Not gonna happen.  1pm brings the final Treasury auction of the week.  30yr Bonds haven't had a big enough market share to get too excited about, but we do occasionally see more trading activity simply because auctions are over for the week.