MBS Live Day Ahead: Time For That Mid-October Craziness in Bonds

Ah mid-October... All too often in the 2009-2014 time frame, we'd seen abrupt reversals of trends at this time of month.  We haven't really been on the lookout for that old behavior because 2014 seemed to mark a shift in that trend.  2014 itself was easily attributed to the massive sell-off in Chinese stocks.  2015 was mysteriously sideways.  And 2016 was understandably sideways ahead of the election.

Even in 2017's version of October so far, we haven't seen nearly the same amount of back-and-forth seen in the 2009-2014 time frame, but as of this morning we are arguably seeing the same pattern begin to play out as bonds are abruptly weaker just days after confirming a positive shift.

Analysts scrambled to explain the move overnight and there's really no cohesive conclusion.  Here's a snippet from this morning's update on MBS Live that lists some of the theories.

• a tradeflow-based correction to yesterday's tradeflow-based curve flattening (in other words, traders showed a bit too much love for long-term vs short-term yields yesterday, and now the opposite is true
• a technical rejection of the 2.28% level, accelerated by the break back above the 2.314 pivot point
• stronger employment data in the UK
• a speech from Mario Draghi that failed to deliver the dovish message that market participants were looking for
• a major technical bounce in European bonds after significant outperformance of US bonds in recent days

This list could go on and on, because none of these are clearly responsible.  Case in point: $/Yen has been grinding steadily higher throughout the European session (it began slightly beforehand, in fact), suggesting there was upward momentum in store for yields regardless of the motivations cited.

I will say that the bigger moves and the bigger instances of volume followed the Draghi speech and the UK  employment data.  But the bounce itself could also be chalked up to exhaustion of the strong overall European bond market rally, with yields hitting a double bottom in German Bunds just before the selling spree began.  Even then, the fact would remain that $/Yen were already on the way up by then, so perhaps traders knew the plan coming into the day and just had to wait for the liquidity of the European session to begin trading it.  $/Yen would offer a more liquid way to do so ahead of time.

And here's a chart that shows all of the above playing out:

In the bigger technical picture, a weaker close today would set us up for a reversal in momentum just DAYS after confirming a positive shift.  While we have overcome such reversals in the past, it's not the most confidence-inspiring position to be in when it comes to making lock/float decisions.  Naturally, we wouldn't want to lock if things progress like they did in July, but we wouldn't want to PLAN on that happening.  So it's a tough call here.  The best bet at this point is to wait to see if there's additional negative momentum that takes yields up and over early October highs.  That would be the more definitive sign of a negative shift.