MBS Live Week Ahead: Light Week For Data, But Plenty of Threats

Pressure is mounting for the bond market.  After a period of intensely calm, narrow trading throughout September, 10yr yields quickly moved to challenge recent range boundaries heading into October.  There are known risks on the horizon, with the presidential election and fiscal stimulus being the two biggest flashpoints.  Should we assume additional momentum toward weaker levels is simply waiting for a few of these shoes to drop?

That depends.  Of the two flashpoints, only stimulus carries an obviously negative connotation for the bond market.  There are two reasons for this.  On one hand, stimulus hurts bonds to whatever extent it helps the economy (a stronger economy supports higher rates and encourages investments to shift toward riskier assets like stocks).  On the other hand, stimulus is directly funded by the issuance of more Treasuries, and more issuance = higher yields, all other things being equal.  Of course markets know that stimulus will arrive eventually, but the longer it's delayed, the more time the economy has to sustain damage and the more time the Treasury market has to trade without another glut of record issuance..

The election is a flashpoint that can go either way--not just in terms of who wins, but more importantly in terms of how markets would react.  The prevailing narrative seems to be that a Biden victory would be bad for rates.  But I've also heard Biden would be bad for stocks.  Given the amount of cash on the sidelines at the moment, I'm not sure both sides of the market are going to sell-off at the same time.  I won't pretend to be able to predict the reaction, and you probably shouldn't listen to anyone who does. 

Another consideration is that the bigger market reaction may well have to do with the potential for unified control of the House and Senate. This makes good sense, but even then, there's one narrative where unified control leads to rampant spending, higher stock prices/bond yields, and another narrative where higher taxes cause stocks to tank and Treasury revenue to improve (thus helping rates).  There are too many variables in play to assume we know how markets will ultimately react, not the least of which being the path of the pandemic.

What's at stake?  The recent ceiling at .79 is an easy target at this point.  It wouldn't take much effort on the part of bond bears (or bulls who are trying to set themselves up for a buying opportunity) to break that ceiling.  The trend over the past three months is definitely pointing in that direction as well.

When and if .79 is broken, the next targets could be appreciably higher.  It would not be a big deal in the bigger picture for yields to make it all the way back to the previous post-covid highs at .96.

Clearly, getting up to .96 looks like it would take some serious bearishness in bonds.  To be sure though, the reaction to major political changes coupled with fiscal stimulus is up to the task--even without any groundbreaking developments regarding the pandemic.  And on that note, the pandemic also serves to limit the potential for bearishness.  Case counts are still accelerating nationwide/worldwide.  Considering the pandemic began in earnest in March, this will be our first winter with covid.  There's a lot of uncertainty about what that will bring.  A bonafide 2nd wave with new lockdowns would almost certainly bring renewed downward pressure for rates while surprisingly solid progress (more people returning to work amid declining case counts/deaths/economic impacts) would quickly make a case for a move back above 1.0%.