MBS Live Day Ahead: Striking Similarities in Trading Patterns Show Year-End Exodus

As we discussed yesterday, the flattening of the yield curve has been a dominant trading theme in 2017.  It's also been a "crowded trade" for bond market participants, much in the same way that buying bitcoin was a crowded trade on Dec 5th-7th or that buying stocks has been since March 2009.  In other words, it's something "everyone was doing" even though there are inherent risks in making the same trade that a majority of other traders are so clearly making.

The past 3 days show the byproduct of "crowded trades."  The "flattener" (traders betting on 2 and 10yr yields moving closer together) has quickly been unwound, meaning traders are exiting those positions en masse.  This can be seen most easily in the green line moving higher in the chart below . 

Incidentally, the movement has taken eerily similar shapes at eerily similar times of day.  The timing coincides with the unofficial open/close hours for bond markets (based on the 8:20-3pm ET pit trading hours at the CME).  This repeated, linear exodus is exactly what the focused unwinding of a crowded trade looks like.  It's why long-term bonds have lost ground over the past 2 days even though stocks have sold.  It's why the most abject leg of the sell-off stopped perfectly at the 2.47% technical ceiling.

Be SURE to note that the sell-off in the curve looked very similar on MONDAY of this week.  And then be sure to remember that Monday only saw a modest increase in 10yr yields.  IT'S THE CURVE TRADING that shows the exodus, because the exodus is from a curve trade (as opposed to a simple "buy 10yr notes" trade).  The fact that it existed in almost identical fashion a day before the big sell-off is another piece of evidence that lets us know what the past few days have been all about.

What are the implications for today?  So far, so good.  In the first hour, we haven't seen the same pattern reemerge.  Neither did we see the same magnitude of pattern in yesterday's trading.  The unwinding of the curve trade may be fizzling out, and that will make it easier for longer-term bonds to attempt to hold their ground around 2.5% (2.52% is the important overhead pivot point).