MBS Live Day Ahead: Deep Thoughts on The Nature of Market Movement

By: Matthew Graham •

For too long and, to this day, far too frequently in many circles, market movement is credited to or blamed on oversimplified "cause and effect" relationships.  I'm talking about the sort of basic binary conclusions such as the following:

  • Stocks slide as stimulus hits a snag
  • Bonds rally after weaker jobs report
  • Bonds slide after stronger <insert inconsequential data here>

Now... I say "inconsequential" in the last bullet point above, but that's a bit too harsh in many cases (but perfectly accurate in others).  A few of the reports that almost always STILL have the power to give bond markets a nudge, even in this post-covid economy:

  • Any of the PMI reports, both ISM and IHS/Markit Manufacturing and Non-Manufacturing
  • Jobs Report (NFP)
  • Retail Sales

But even then, we've seen just as many examples of each of the above reports failing to inspire movement in the logical directions.  Moreover, in many cases where it seems that these reports are moving the needle, we're actually seeing the effects of something else.

Defining this "something else" is a bit tricky because there are several different types of traders who trade for several different reasons.  At any given time, one group may be having more of an influence on market movement than another.  For instance, highly-leveraged "fast money" and/or algorithmic traders can be entirely responsible for the sharper moves seen immediately following key headlines.  Day traders could pile in to the same trades at the same time only to look for an opportunity to book profits and get out later in the day.  

Those trades could be offset or counterbalanced to some extent by "real money" who are beholden to the allocation preferences of their clients in many cases (but who have longer time horizons regardless) viewing that sharp move created by "fast money" accounts as a buying/selling opportunity.  Here's an example:

  • NFP comes out much stronger than expected during the height of post-covid economic malaise.  Real money accounts figure we're in for the long haul and they see yields being high enough to be a buying opportunity even before NFP.  But fast money accounts do the logical thing and push bond yields higher right after the report.  For a moment, it looks to us market watchers like "NFP matters!"  And for a moment, it did.  But then real money traders seize the lower prices to execute the trades they were planning on making and yields ultimately move lower simply because that's the buying opportunity that stronger hands were looking to grab for the day.  

How many times have we seen that seemingly counterintuitive movement on any given day with seemingly big data?  The point is that there is almost always more than meets the eye going on behind the scenes of any sharper/bigger bout of market movement.  Econ data can also be used as cover for such moves.  Here's an example:

  • Bond traders showed up to sell (i.e. push yields higher) yesterday.  This was readily apparent for reasons we'll discuss in a moment well before the day's big econ data.  But around the time of the econ data, yields were moving higher, so the conventional-wisdom-based market watcher concludes yields moved higher due to the data when in fact yields were very likely to end the day higher regardless.  

Did the data add to the move in that case?  Probably, but it's hard to say for sure.  What we can say for sure is that the data was gladly used as cover for traders to make the trades they were planning on making anyway.  Bonds were adding momentum after a technical breakout.  Even the bond bulls in my circle had been talking about the need to push yields a bit higher and set up for another buying opportunity some weeks or months in the future. 

After a bullish September (relatively), October was set to begin with a round of big Treasury auctions.  Add Trump's return to the White House, the ongoing stimulus debate, and an ongoing recovery in stocks, and early October--especially the Monday before auctions start-- feels like a great time to push yields higher.  If nothing else, it helps facilitate another record slate of 3/10/30yr auctions on the same week as high corporate bond issuance---all before a 3-day weekend where we can assume liquidity will have dried up by Friday and be slow in returning on Tuesday.

Oh, and then there's the stock market... In the post-covid market environment, it's been much more important than normal--especially in September when the big stock correction arguably prevented bonds from continuing to drift gradually higher in yield.  On several occasions in mid September, I warned that bonds were only holding as flat as they were due to the uncertainty created by the stock sell-off.  Now as stocks make stronger gestures toward recovery, we've seen 9:30am (NYSE open, and flood of liquidity and activity for stocks) become one of the prime times of the day for bonds.  Need proof?  How about every one of the past 4 trading days?

Notice the last one also highlights the CME Open--a time of day so important it has its own MBS Live primer (HERE).  It's usually fairly ominous to see a spike in bond yields at 8:20am on a Monday morning--even more so when that Monday is anywhere close to the first trading day of the month.  It can signal that sellers are/were lined up to set new short positions for a new month/week. Finally, if the previous month was slightly stronger for bonds, it only adds to the case for negative momentum that transcends and supersedes the type of tidy, logical, discrete cause and effect relationships that years of oversimplified analysis have numbed you to. 

Yes, there are times where market movement IS actually that simple, but they've increasingly grown to be the exception in this age of overly-abundant data and real-time electronic communication.  Today's investor is savvier than ever.  Whereas a trader with access to real-time newswires had a distinct advantage over scores of others waiting for their paper copies of the journal, now everyone has instant access to data that is universally known to produce the same binary choices every time.

Well guess what! I've said it before and will say it oh so many more times: when every trader has the same information and is planning on reacting the same way, markets often do the OPPOSITE thing, OR if they move in the logical way, it was for a completely different reason (remember those "hide behinds" discussed above?).  After all, if everyone is on the same side of a trade, it's hard to make money.

The bottom line of this post is quite simply to serve as a reminder that "it's rarely that simple" when it comes to connecting one dot of data or news to a logical reaction in the bond market.  We're constantly balancing long/short/medium term trading considerations, economic implications, fiscal/monetary policy, global interdepencies, issuance fluctuations, and many other factors against the wants, needs, and even the emotional reactions of several distinct groups of traders (who all may have different wants/needs/emotions depending on the moment/hour/day/week/month/etc). 

We can only ever try to hone in on the best few reasons for any given market movement and hope we're right.  With occasional exceptions, to assume you know exactly why something has happened or will happen in the bond market is risky at very best, and dangerously naive at worst.