MBS Live Day Ahead: One More Way to Look at Recent Volatility

Yesterday brought an early interruption to the range breakout that began late last week.  Such bounces merit caution as they often simply act as a short-term correction for a new, negative trend.  A second day of stability today would be more meaningful as it would suggest other forces may be at work.

What might those "other forces" be?

There's a chance that bonds weren't actually ready to break out of the recent range, but instead got caught flat-footed by Trump's surprising Fed rate hike comments.  In these summertime trading conditions (less liquidity), and with a majority of the market comfortably betting on further flattening of the yield curve (2s and 10s moving closer together, largely due to rising 2yr yields), it doesn't take too much of an unexpected move in the yield curve to set off a quick wave of position squaring.

In other words, if traders were largely betting on a flattening curve, and if the curve unexpectedly steepened enough to take out a key technical pivot point, it would make sense to see a fair amount of momentum toward a steeper curve as traders covered those flattening bets.

In OTHER other words, when the green line rose above 0.27 in the chart below (and again when it rose above 0.30) traders that were betting on the green line moving lower temporarily abandoned those bets, thus pushing the green line even higher.  And a higher green line implies pressure toward higher 10yr yields and lower MBS prices.

If we now see the curve hold below 0.30%, there's a chance that this range breakout was indeed driven by these curve trades.  But with 10yr yields starting the day very close to 2.95% yet again, it's a bit too soon to get too excited for such prospects.  We still have the European Central Bank announcement tomorrow morning and GDP on Friday.  In the most immediate future, this afternoon's 5yr Treasury auction could prove to be informative as well.