MBS Live Day Ahead: Don't Trust Anyone Who Tells You What's Moving Markets

By: Matthew Graham •

In the day just passed, bonds held their ground after overnight weakness and eventually moved back into positive territory.  That happened in spite of an ongoing correction higher in stocks (notable because a stock sell-off was a centerpiece of the previous day's rally).  In other words, bonds were doing their own thing for their own reasons.

In the day ahead, bonds will continue to do their own thing for their own reasons.  In fact, this is already painfully evident overnight.  The pain is made all the more painful by analysts (armchair or otherwise) tripping over themselves to explain why we've had another 10bp rally in 10yr yields overnight.  The following list of potential market movement scapegoats has support from twitter crackpots as well as intelligent and thoughtful market analysts--several of whom I'd consider as some sort of mentor.  

  • Another weak Yuan-setting session from the People's Bank of China overnight
  • Weak German Industrial Production data late last night
  • Surprise Central Bank moves in India and New Zealand (and Thailand?)

I like to keep an open mind, and I REALLY like to ferret out cause&effect when it legitimately exists, but that's sadly not the case with anything on this list.  Let's examine:

Chinese Yuan is always going to be a leading suspect in the current rally cycle.  It was at ground zero last week and then again 2 days ago when things got even crazier.  Now today, overnight reports make the connection sound clear: the Chinese central bank just set a weak level for the Yuan just like it did early Monday morning.  This must be it, right?

Nope... there's perhaps a bit of incidental correlation here, but no causality.  How about the Central Bank rate cuts in New Zealand and India?  These are getting a ton of press overnight.  First off, I have to laugh...  New Zealand?  Are you kidding me?  Nothing against my Kiwi buds, but they're not now, nor have they ever been relevant market movers.  When analysts start bringing NZ into the scapegoat discussion, it's clear that the straw-grasping has begun in earnest.  India's not much more compelling, and in any event, didn't correlate at all with domestic markets.

So where were we?  Weak European data and/or EU bond rally leading the way?  A general EU rally and subsequent spillover to US trading is probably the "best of the worst" when it comes to red herring scapegoats.  Hilariously, the European analysts I'm reading this morning are generally using yesterday's US bond rally as their own scapegoat.  

I didn't even highlight the German econ data on the chart because it didn't garner a reaction at all.  The big drop in Bund yields around 4am (without any drop in Treasury yields) is the most interesting part of the chart because that's simply the EU bond market open--new liquidity coming into the market... traders waking up and saying to themselves "you know what... I think I better buy some more bonds today."  The next rectangle to the right is the American version of the same story.  The US rally kicked into higher gear shortly after traders' alarm clocks started going off in the US.

This then, is the best and perhaps the ONLY way to intelligently talk about bond rally motivations.  Traders are waking up (literally and figuratively), taking a look at the overall lay of the land, and more of them are deciding it makes sense to buy versus sell.  I know that seems horribly pedantic, but sometimes traders are just trading for reasons you and I don't get to know.  Sometimes it's momentum/technicals.  Sometimes it's the simple fact that betting against the bond market is not an option.  Sometimes it's compulsory trading due to the hedging process surround corporate bond issuance or to the money management process whereby investors have to adjust holdings based on client deposits and redemptions.  

One thing's for sure, we can't rely on seemingly important calendar events to be leading market movers in this environment.  The next big move will come completely of its own accord or due to an unscheduled/unexpected news headline.  Between now and then, all we can do is us a technical framework to set up defensive yield ceilings with the goal of identifying a significant threat to epic rally of 2019.