MBS Live Day Ahead: Checking In With Bigger Picture (Treasury vs MBS)

It may end up being a slow, summertime Friday with the news cycle calming down relative to earlier in the week, not to mention the fact that its peak vacation season (traders take vacations too, ya know!).  That gives us a moment to step back and reflect on some bigger picture trends. 

US rates have been playing Red Light, Green Light with global risks all year.  If they had their way, they'd continue moving higher, but they slowed their roll and settled into a more gradual pace after the Italian political drama in the middle of the year.  The weeks leading up to the Italian drama ended up looking like a big, temporary breakout of what would eventually become the sideways-to-slightly-higher range.

Subsequent global risks haven't measured up to Italy in terms of bond market impact.  Trade-related concerns (mostly a China story) come and go.  Most recently the Turkish currency crash teamed up with fresh trade drama to help bonds.  Notably, that was only just enough to get us back to the lower end of the range.

But of course Treasury yields aren't the full story when it comes to mortgage rates.  There, we've seen a common scenario unfold.   Simply put, mortgage rates have risen just as much as Treasuries but have been slower to return to previous levels.

Part of this has to do with the fact that MBS tend to do better than Treasuries when yields are spiking rapidly and worse when yields are falling.  Reason being: Treasuries are first to react to big market movers.  Treasury trading positions also have more of a domino effect during times of volatility (for better or worse).  The only major exceptions occur when a mortgage-specific shock comes along (like the early days of the Financial Crisis or QE3, which targeted MBS specifically).  Apart from that, MBS are just doing what they normally do when a Treasury rate spike stabilizes.  

As for today, if we're not breaking below 2.82% or above 2.9% in 10yr yields, nothing notable is happening.  Volume is starting out on the very light side and should stay that way.  The only caveat is that low volume and light liquidity can occasionally result in bigger moves than we'd otherwise see, but that requires a few traders straying from the beaten path.  We haven't seen any signs of that yet, with this morning's Treasury strength more easily explained by overnight weakness in Chinese equities and a cooling off of a big 2-day rally in US equities.