MBS Live Day Ahead: It's Still a Correction Unless The Fed Says Otherwise

In the week just passed, the bond market sold off at the fastest pace since the June 2013 taper tantrum.  That's a relatively impressive feat at first glance considering the taper tantrum provided a massively obvious, once in-a-lifetime selling cue whereas last week arguably only had a few moderately important negative indicators for bonds.  But consider that yields had already risen 60bp from recent lows BEFORE the taper tantrum sell-off compared to roughly 10bps this time around and things make more sense.  The more appropriate comparison would be with early 2015 where  yields had been trending lower at a linear pace for more than a year before a last-minute acceleration of the rally and a subsequent corrective bounce in early February.  Long story short: the nature of the 2019 rally and especially of August's acceleration in buying demand is the key culprit behind September's corrective bounce.

In the week ahead, we'll continue pondering the disposition of this correction.  Is this just the beginning of a bigger move back toward higher rates, a pressure release for a market that wants to continue toward lower yields, or a resetting of the board for a game that can still go either way?  

While I'll be the first to tell you that interest rates in the US will definitely hit new all time lows during the next recession (or sooner), I think the neutral assessment is the only one that makes sense (board reset, new game, undecided result).  Quite simply, the economy either gets a mid-90's style second wind after some mid-cycle Fed rate cuts and the eventual de-escalation of the trade war, or a recession happens either way.

This week's Fed announcement won't be the deciding factor in the bigger-picture narrative, but it still has plenty of power to create volatility in the short term.  Think of it like this: the Fed is like a storm chaser following the unpredictable storm of economic momentum.  The market along for the ride with the Fed in their storm-chasing plane/train/bus/whatever.  Nothing the Fed does is going to change the course of the storm, but the way in which they pilot their storm-chasing vehicle has a profound effect on the market's experience.

The rate cut announcement is on Wednesday at 2pm.  A rate cut is currently seen as 100% likely and therefore, not a market mover.  Any major market reaction at 2pm will be a factor of the Fed's updated rate projections or notable verbiage changes in the announcement itself.  Then at 2:30pm, Powell's press conference has the same potential to prompt a volatile response.  Bottom line: markets want to know if the Fed is going to drive toward this storm optimistically (i.e 1 or 2 more cuts and that's it) or pessimistically (more and more cuts unless conditions improve).  The pessimistic Fed would almost certainly end the current bond market correction whereas the optimistic Fed could push rates even higher in the short term.  In that scenario, the selling would run its course fairly quickly and then wait for economic data and other fundamentals before deciding on the next move.