MBS Live Day Ahead: A Story of Supply, Momentum, and Conviction

Let me take you back--but not necessarily "way back"--to March 2017.  Geopolitical risks weren't on the radar yet (no Syria air strike, North Korea threats, or comments on Russian relations being at an all-time low).  Neither were the fiscal policy missteps that would soon shake investor confidence in the government's ability to enact the new legislation upon which many hopes were pinned.

Stocks had just pushed to new all-time highs, and bonds had just bounced at 2.30 for the 3rd time this year.  Here's how a chart looked at the time:

Stocks muddled sideways for a few weeks as bonds freaked out about the mid-March Fed Announcement, but then things changed.  The Fed hiked, as expected, but their forecasts didn't increase as much as expected.  Bonds had braced for too much pain and were thus able to recover a bit.  Shortly thereafter, the fiscal missteps kicked in and helped the "risk-off" trade flourish (weaker stocks, stronger bonds).  

Throw in a bit of geopolitical risk and soon we had a clear downtrend in both stocks and yields that lasted all the way through the French presidential election.  Bonds, in particular, made impressive progress during that downtrend (seen in the chart below).  They were positioned for a potential upset in the French election.  When they didn't get it, much of the early April conviction was called into question.

Traders looked around and asked themselves if there was any reason for yields to be moving lower, out of the prevailing 2.3-2.6 range.  Over the past 2 weeks, we've gotten our answer.  Here's how the updated charts look (with the past 2 weeks being the smaller bubble inside the bigger bubble):

As you can see, bonds haven't stampeded back toward the heights of the "risk-on" trade in the same way that stocks have, but they've nonetheless undergone a shift in momentum.  Zooming in on a chart of 10yr yields only, with some technical overlays, we can see this momentum in play:

Again, this isn't the same sort of "high conviction" move seen in stocks.  It's more about a lack of conviction (or justification) to continue inside the yellow trendlines.   The only question is how far this new momentum will carry us before something changes.

In that regard, we can consider that we're coping with lots of "supply" this week.  That just means that there are a lot of bonds being sold, both by the US Treasury and by corporations.  As always, keep in mind that corporate bond issuance puts pressure on the entire bond market because it's yet another competitor for fixed-income investors' attention (not to mention the fact that corporations can effectively "lock their rates" by selling Treasuries).

Bottom line, we're under some pressure at the moment.  We'll have a better sense of the conviction behind that pressure after we work through the brunt of this week's supply (Thursday afternoon).  Between now and then, assume an uphill battle for bond market optimism.  The bandwagon is unfortunately simply heading in the other direction for now.