MBS Live Day Ahead: Bonds Have Lots on Their Mind, But Beware The Bounce

As we begin the third day of moderate weakness in bond markets, it's safe to say that we're looking at the correction and/or consolidation that we expected to see as of the end of last week.  Bonds wouldn't have needed any other reason apart from the preceding rally to bounce.  But as that process unfolds, it's been complicated by other competing stimuli.

These include but are not limited to Brexit-related drama, trade war news, the stock lever (stock prices and bond yields moving together), the Treasury auction cycle, and year-end trading position housekeeping.  Depending on when you look, you might see one of these factors having more of an influence than another.  For example, yesterday saw US bonds take more guidance from Europe while today has seen more of a stock lever effect so far.

It's hard to see in the chart above due to the way things are scaled, but yesterday's stock losses began WELL after European bonds began to pull Treasuries lower in yield.  In fact, Why don't I just drop a vertical line into the chart to show that most of the bond rally had already happened by the time stocks began to sell.

All of that microanalysis may be beside the point, however.  If we zoom out just a little bit, we can see that--although there are indeed pockets of varying correlation--the bigger picture actually shows everything moving together, for the most part.  The other takeaway is that core bond markets (like US and Europe) tend to remain more correlated than bonds and stocks.

Back to the purely technical standpoint now (from the first paragraph, where we discussed bonds not needing any reason to bounce apart from the strength of the recent rally).  There's no question that some sort of bounce is underway.  The theme of our conversations so far this week has been to hope that the bounce is simple the first phase of a CONSOLIDATION rather than a correction.  Even though next week's Fed announcement is ostensibly the next big mover, we need to stay vigilant.  Any further weakness will begin confirming the technical warning sign we've been discussing for more than a week (potential breakout highlighted with "danger!" below).