MBS MID-DAY: Living In The Shadow of Treasury Snowball Rally

Life isn't always fair for MBS.  Sure, there was QE3 which specifically targeted MBS over Treasuries, leaving the latter out in the cold on a relative basis, but for the most part, Treasuries get to have all the fun.  Case in point, the price on a 10yr Treasury note is currently up 28 ticks on the day versus a gain of only 14 ticks for Fannie 3.0s.  If we want to talk yields, that's nearly 10bps for Treasuries.  We'll be lucky to see a gain of more then 4bps in effective mortgage rates.

What's up with that?

First of all, Treasuries almost always lead the charge, whether it be higher or lower.  They lose ground more quickly when the going gets tough, but they rally in a way MBS can only dream of when global markets are flying to safety or sidelines. 

Today is an example of the latter, in that Treasuries are flying both to safety AND sidelines.  How can a rally be a flight to the sidelines, you ask?  Simple--as long as you remember that trading positions can be both long and short.  A short position gives the seller the right to buy back the security in the future (because they think prices will move lower and yields will move higher).  Short positions are closed by buying. 

This so-called "short covering" is always playing some role in any snowball rally for Treasuries because there is always some portion of the market that is short.  When other motivations bring yields low enough (today, that's falling oil and stock prices), some of the short positions hit stop-less levels and automatically buy (to close the short position).  Of course this only creates more buying demand in the market and triggers the next trader's stop-loss trigger.

Bottom line, this has nothing to do with today's data or with any leak of next week's Fed Announcement.  It has quite a bit to do with the significant weakness in stocks and oil, and just as much--if not more--to do with the snowball dynamic and flight to the sidelines ahead of next week's Fed.