MBS Live Day Ahead: Defensive Shift is a Cause For Concern; Yields Struggling With an Important Floor

The GA senate election shift is old news.  It did the damage it was always likely to do, but bonds had a good show of support by the end of the following week.  That made good enough sense considering the pandemic is driving the market and the pandemic can't be quickly defeated.  But it's worth noting that the pandemic is also driving central bank policy, and when those policies are tweaked--even subtly--bonds can and will react.  This morning's change to the ECB's PEPP is the latest example.

If you didn't click the link above, the nutshell version is this: the European Central Bank made a subtle change to its pandemic relief bond buying program that COULD mean it will buy slightly less than the maximum amounts.  When these programs are initially announced, markets account for a scheduled amount of bond purchases (good for rates).  If central banks say or do something to call those amounts into question, bond markets adjust their expectations accordingly (bad for rates).  That's what we're seeing this morning.

Additionally, ECB President Lagarde made several remarks during today's press conference that weren't entirely negative/downbeat.  Bonds reacted to those too.  

The net effect is a moderate amount of upward pressure in bond yields today.  While this isn't the biggest day of selling we've seen recently (not by a long shot), it comes at an inopportune time.  10yr yields have been trying for days to break below 1.075%.  They've come within 1bp of that EVERY day for the past 6 days, and they've actually touched that level on 4 of those days--with the wee hours of this morning providing the most recent example.  The bounce was already in place before the ECB policy announcement and press conference, but those events added to the weakness.

NOTE: on the chart above, the simultaneous sell-off in stocks and bonds is a hallmark of a reaction to lower expectations from a major central bank (central bank bond buying is typically considered a rising tide that lifts all ships, i.e. good for stocks and bonds).

Another note on the chart above is that it was created at the worst point of the morning so far.  We've bounced a bit since then, which is reassuring in the short term.  In the bigger picture, however, let's go back to that 1.075% level.  We have been a bit worried that the friendly bounce last Tuesday continually failed to materialize into a deeper, positive correction.  1.075% has quickly become the waterloo for said correction.  That's the level to beat at the moment (and it has yet to be beaten).  The risk here is that yields are simply consolidating the recent weakness before another jump.  The longer we fail to break 1.075%, the greater the danger.