MBS Live Day Ahead: Scary Scenario Playing Out in Bonds

This morning's alert notes that the bond market is in the midst of one of its scarier scenarios.  The ingredients are as follows: a long run in a record low rate range with uncommonly strong help (both from the Fed and from the market movers in play), the gradual realization that the record run is justifying a shift toward higher rates, a key political change in the form of one party controlling congress and the White House, and increased ruminations among Fed members about how much longer their uncommonly strong help will last. 

Throw in the fact that the biggest jolt of momentum coincides with the start of a new year and this has all the makings of a moment you may wish you took more seriously in hindsight.  Actually, that moment happened a week ago yesterday (the day before the GA senate election with rates at all-time lows and my commentary sounding like a broken record with respect to breakout risks).  Now we're hoping to see some relief--the first correction to a selling spree of unknown size.  

Hope only got us so far yesterday.  10yr yields were actually telling a pretty good story before 4pm.  Given that we are often willing to overlook volatility that happens after the 3pm CME close, we technically still had a chance to see bond yields make a case for a ceiling near 1.1375%.  But overnight weakness introduced the 1.17+ level--something I'd put on the list of pivot points last week, but had hoped not to see quite so soon.  

In fact, the past 2 days have seen several hopeful consolidations quickly give way to new breakouts.  Monday's was probably the most hopeful as overnight trading (and even early domestic trading) suggested 10yr yields might be rejecting a break above Friday's highest yields.  Hopes were dashed at the 9:30am NYSE open, but not excessively.  Bonds were right back into another consolidation just under 1.1375%.  The late day break gave way to another consolidation overnight followed by another breakout earlier this morning.

This is exactly how they get you!  Hope followed by disappointment, time and again, in small enough steps that you never end up panicking as much as you should.  With recovery potential seemingly around every corner, it's easy to hope that the worst is behind us each time bonds begin fighting for the next ceiling.  If that sounds like your approach, please refer to the chart above, or the chart of daily 10yr candlesticks below. 

In the chart above, yesterday and today are challenging the pace of the prevailing uptrend.  This could be good or bad.  On one hand, buyers sometimes use that upper line (aka "trend support") as a signal that selling has gone far enough to justify some dip buying (where "dip" refers to bond PRICES even though we're always thinking and talking about Treasuries in terms of YIELD).  On the other hand, trend channel breakouts are also dangerous if they're followed by additional negative momentum.

I will maintain that it's hard to justify too terribly much more additional negative momentum in the short term.  I don't know anyone who thinks 10yr yields can sustain a break above 1.25% in January (granted, I don't know everyone).  Defensiveness makes sense early this week, and not just in hindsight.  Friday's recap ended with the following sentence: "If we're going to get a bounce that helps ease those concerns, it may depend upon how next week's Treasury auctions are digested."

Today brings the 10yr Treasury auction--a key event in determining how traders are feeling about new yield levels.  Last week's conclusion deserves to be reiterated.  A combination of oversold bonds and the presence of a 3/10/30yr auction cycle is a quintessential recipe for friendly bounce.  If it weren't for Thursday's anticipated Biden stimulus unveiling, I'd feel more confident that we were about to see such a bounce.  It could still happen, but the pace of gains (if any) would likely be limited until we see what Biden has to say.