MBS Live Day Ahead: Bonds At Mercy of Earnings Ramp-Up, But Curve Could Help

The term "earnings season" gets thrown around quite a bit in financial news, but what is it, exactly?  Simply put, it's a period of several weeks each quarter where a majority of companies release their earnings reports.  This is always of interest to the stock market as it's something of a report card for parents wondering how their children are doing in school.  The first quarter of 2018 is especially interesting due to tax law changes.  It's as if the children are in a new school or using some revolutionary new study aid.  All that to say: the number of earnings releases went from the teens to the 40's yesterday as it builds toward more than 200 next Wednesday and more than 300 on the following Wednesday.

Bonds don't necessarily care as much as stocks, but they still care.  While the stock market may not be the primary input for the bigger-picture moves in bonds (for that, we'd look to Fed policy, the Treasury issuance outlook, and growth/inflation), the correlation is very high during periods of indecision and consolidation.  And bonds have have certainly been in such a period since late February.

To some extent, geopolitical and economic risks can affect both stocks and bonds in such a way that the correlation happens naturally.  Case in point, trade war fears simultaneously hurt stocks and cooled the underlying growth/monetary policy outlook that informs rates.  When trade war rhetoric came off the boil, it marked a reversal for both stocks and bonds.  As long as it remains on a simmer, we're not likely to see a big bear market take shape in stocks.  From that more stable baseline, if earnings season helps stocks move back up to 2018's previous highs (and above), it would very likely put renewed pressure on bonds to do the same.

In terms of outright technical levels in yields, 2.86% remains the most important nearby overhead ceiling.

Is there any hope?

There's always hope.  It just depends how long you have to wait or how bad things have to get before the hope manifests a positive outcome.  As we've discussed, we could be waiting many months for a new, profoundly positive trend in bonds.  One narrative I like at the moment is that of the "yield curve" (the spread between longer and shorter-term yields, usually expressed in terms of 2yr vs 10yr Treasuries).  The curve is a perennial indicator of recession when it goes below zero.  Right now, almost everyone who speaks or writes on the topic is quick to assert "this time is different" when it comes to the natural market cycles that have consistently taken the curve below zero.  But is it? 

Seems like a bold call for so many people to be making when we're currently only 44bps away from inversion, but time will tell.