MBS Day Ahead: Jam-Packed With Data Destined to be Trumped by Holiday Dynamics

Last Friday, I talked about some of the general bond market dynamics we tend to see around this time of year.  It wouldn't be a bad idea to check that out if you missed it.  Today's notes will focus more on this week specifically, as well as the current state of play in longer term trends.

Bond markets find themselves leveling-off and consolidating after a medium-fast move to higher yields.  The move was motivated by the Fed Announcement in late October that served as a warning to market participants that the Fed was likely to hike rates in December.  Anyone who wasn't convinced by the statement itself was forced to reconsider after the balmy NFP numbers at the beginning of November.

The post-NFP sell-off didn't last long, and that's part of the reason it's important.  It gave us a very solid idea of the important support levels in bond markets, because of the way selling pressure evaporated and gave way to bond buyers looking to get in the market at more attractive levels.  This sets up a pivot point for us to watch: the pre-NFP low yields around 2.23.  Getting back under the 2.23 level would be the biggest short term victory.  We can see it's significance in the following chart as US 10's haven't even thought about breaking it despite plenty of encouragement from global bond markets.  On a positive note, we can also see the 2.30 ceiling stepping in for support. 

While there's no rule that says US rates have to follow European rates in lock-step, this has been a notable divergence.  Certainly, we can explain some of it by saying that European bond markets should logically have a bigger flight-to-safety response to the Paris terror attacks and subsequent German stadium evacuation in Hannover.  But we can also consider that the recent flatness in US 10's is a logical 2nd step no matter what the longer term trend will be.

In the case of a broader sell-off, the recent flatness would be the logical "consolidation before more selling."  In the case of a bounce, the recent flatness would be the first sign of a hard-fought establishment of support (like the choppy, sideways action seen in June after the heavy selling in May).

Until we see more commitment to a rally, we have to stay on guard against the possibility that it's merely a pause before more selling. The good old "death cross" (50 day moving average crossing 200 day moving average) actually provides a convenient way to monitor the situation.  It's recently flattened out with each moving average right on top of each other.  The same thing has happened on several occasions over the past few years, with the flattening of the moving averages ultimately giving way to more selling. 

That might seem pessimistic, but keep in mind the time frames like 2003-2007, when there was essentially no rhyme or reason behind the longer term moving averages.  We may well be entering such a period, where yields have been compressed against a lower bound and try to move higher initially only to find that there's no fundamental justification (in 2003-2007, we only managed the fundamental justification of an unsustainable housing rally/bubble).

Broader themes will likely continue to be a bigger driver of bond market movement than the data in the near term.  This wouldn't necessarily be the case, but on a holiday week, it's the trading positions set up for those broader themes that will do most to move markets as participation dwindles.  That might be a bit confusing.  There are always trading positions set up with goals that related to the broader themes, but on a holiday week, decreased participation means those strategic trades will have more of an impact than normal.