MBS Live Morning: Highest Yields in 2 Years as Selling Spree Continues

Bonds sold off last Friday after 4 days of relative stability and improvement to start the week.  Optimists hoped the weakness was a byproduct of the impending 3-day weekend (we occasionally see big, counter-trend moves on the preceding Friday), but those hopes have quickly been dashed.  Selling was relatively aggressive overnight and volume was heavy.  10yr yields hit their highest levels in almost exactly 2 years (1.856).  MBS are starting out at least a quarter of a point lower. 

There were no standout market movers to blame, at least not in terms of obvious, short-term motivations.  The vast majority of the last 2+ weeks of selling can be narrowed down primarily to the shift in the Fed's policy outlook.  This isn't only about rate hikes, but also about balance sheet normalization, which means Fed bond buying will be decreasing again, probably by the end of 2022.  As such, longer-term bonds and MBS have taken plenty of damage.  10yr yields are now at their highest levels in almost exactly 2 years.

The shift in 2yr Treasuries tells the story even better.  The short-duration bond does a much better job of capturing the Fed's rate hike outlook which effectively exploded in the 4th quarter.  It's interesting to see how linear that explosion has been in 2 year yields compared to 10s.  This speaks to the relatively bigger impact that balance sheet normalization has on longer-term bonds.

While it's true that 2yr yields have been more linear in their selling, they've certainly accelerated in early 2022.  After all, if the Fed is shifting as aggressively as they are, the rate hike outlook is naturally going to be part of that.  Case in point, here's the big sell-off in Fed Funds Futures.  The lower the line, the higher the expected Fed Funds Rate by December 2022 (the pace of selling is similar for every other contract date starting with March 2022).