MBS Live Week Ahead: Bonds on The Defensive as Range Breakout Looks More Serious
The incredible range trade of Q3, 2020 is well established and, by now, hopefully well understood. The boundaries are clear in terms of 10yr yields with .62+ on the low end and .72+ overhead. The range has been completely unbroken for a month and, if you can forgive one false alarm breakout to .79%, it's been unbroken for nearly 2 months. Before that, we could go all the way back to April through early July and view the same levels containing most of the trading action. In short, this is the core of the post-covid sideways range in the bond market.
Last week began with yields being squeezed in such a narrow consolidation pattern that a breakout was inevitable (yellow lines below). Yields broke to higher levels. In these cases (were a consolidation pattern inside a broader sideways trend is broken to the upside), the most basic inference is that the next technical test should take place at the ceiling of the range. In other words, breaking out of the yellow triangle pattern implied a visit to .72+. While this happened briefly on Thursday, this morning's version looks more serious.
It's not only more serious because yields have moved a bit higher. There are also a few clues in the intraday trading patterns. Specifically, on Friday, yields moved up and above an intermediate pivot point at .69% and then bounced there as a floor multiple times. While this isn't really a definitive confirmation of risk--especially on a Friday afternoon--it can be the market's way of offering a bit of a clue about the potential risks ahead.
Keeping in mind that we have a 3-day weekend coming up and Treasury supply (big bond auctions) on Tue-Thu this week, it wouldn't be a surprise to see bonds let short positions win a few rounds (i.e. higher yields/rates). In the eyes of bond bulls, this would effectively reset the table for the next push toward lower yields. That said, it doesn't make much sense for anyone to be too bullish or bearish right now (which is the entire reason we're talking about prolonged, narrow ranges in the first place).
Nonetheless, moderately volatile moves can and will happen even inside broader sideways ranges. As I've warned for weeks, the recent stint between .62-.72 is too narrow to last very long, and a better way to think about a broad sideways range would be 0.5 to 0.95%. The reason to watch narrow ranges is to try to get ahead of negative momentum that might be interested in exploring the upper levels of that broader/wider range.