MBS Live Recap: Bonds Tank, Rates Spike, No Satisfying Explanations

In a perfect world, massive sell-offs in bond markets would have logical explanations--the sort of tidy cause and effect relationships often seen following the big jobs report back during the days when markets cared about it much more than they do now.

Run-on sentences aside, the point is that motivations are more opaque at the moment.  We don't just have one overarching event moving the needle.  There's no big jobs report.  There's no taper tantrum, Brexit, Greek debt crisis, or ECB QE.  Instead, we have a combination of events creating a theme and that theme, in turn, creating some less easily understood trading motivations.

One set of events centers on central bank policy.  Specifically, Japan and Europe are increasingly following in the Fed's footsteps with respect to extracting themselves from the bond market driver's seat.  To whatever extent they succeed, the worse it is for rates.

Meanwhile, the US government will need to be issuing more debt in order to pay for recently enacted policies and may need to issue debt to pay for policies that haven't yet become law (like the infrastructure spending draft that was "leaked" last week).  

All of the above adds bond market selling pressure, especially in the front of the yield curve (shorter-term bonds like 2yr Treasuries), which comes under pressure even if central banks only manage to hike rates (and not necessarily cut bond purchases).  Treasury has also said it would fund spending primarily with issuance in shorter-dated Treasuries.

The problem with that is that the yield curve is about as flat as it wants to get for now, so selling pressure on 2yr yields equates to pressure on longer-term rates as well.  

News over the weekend raised fresh concerns about foreign central bank policies.  Japanese traders aggressively sold Treasuries overnight.  European traders sold Treasuries in the European session.  Domestic traders were forced to sell as technical ceilings were broken before they ever sat down.  There wasn't much selling left to be done by the time domestic hours got underway.  This allowed bonds to cool off a bit as the day progressed, but yields never even came close to re-entering last week's trading range.

The resulting "gap" (a jump up from last week's highs to this week's lows) serves as a painful reminder of how serious the current move is and how challenging it will be to defeat it.  The gap also provides yet another technical line in the sand that will serve to let us know how any sort of push back is progressing--assuming we see such a push back in the next few days.