MBS Live Day Ahead: Take This Shift Seriously

In some nearby parallel dimension, the letter "f" is option in today's title.  We'll have to remember this little trick the next time bonds bounce so we can refer to it as a "bull shift," but I digress.  The thesis is that there's serious 'shift' going down in bond markets.  After months of the best rally momentum in years, the case for a correction is growing.  In fact, if we were to look purely at fast stochastics (a shorter-term momentum indicator seen in the blue/red lines in the following chart), the shift has already begun.

The green and teal lines represent the slow stochastic oscillator--a longer-term momentum gauge--which has yet to confirm the shift.  All of the above is a complicated way of saying that bond markets have started unwinding some of the recent rally, but haven't bounced too hard just yet.

The best case scenario for the days/weeks ahead is that this mini-bounce is just a byproduct of a bond market that needed to catch its breath.  We often discuss the fact that such consolidations/corrections actually help bonds hold onto gains (or realize further gains) in the bigger picture.  One way to visualize this is via 10yr futures trading positions. 

After hitting record net-short levels (traders betting on higher yields) in late 2018, positions bounced and traders began paring shorts.  A net-short level of nearly -800k quickly rose just above -300k.  As the dotted lines in the following chart show, -300k to -400k is a bit of an inflection zone for trading positions.  Before 2017, -300k was the floor.  Before 2018, -400k was the floor.  It would make sense for traders to pause for reflection in this zone.

Sadly, none of the above has a bearing on the future. The point is that there are two compelling cases to be made.  I think the momentum shift has to be taken seriously (i.e. it's an easy call to play defense here), but there is at least one way to look at the shift as a potentially temporary consolidation.