MBS Live Day Ahead: Is a 5 Year Time Frame Long or Short?

If Yesterday's big to-do was Fed Chair Powell's testimony, today's will be the 5yr Treasury auction.  Notably, Powell didn't have a big impact.  His comments did more to confirm the trading that had already taken place in the past few weeks.  The Treasury auction is a bit trickier due to the 5yr note's location on the yield curve.  

The 5yr is sort of in the middle ground when it comes to the yield curve.  It's short enough to escape much of the pain experienced by 10s and 30s when the curve is steepening but long enough to avoid being beholden to the Fed Funds Rate outlook (unlike 2yr notes, for instance).

If all of the above is confusing, consider the following chart.  It shows the longer end of the yield curve at the highest levels, but making the strongest gains in the past month.  In contrast, the short-end has been super low and super flat (mimicking the Fed Funds Rate outlook) until bumping higher just last week following the Fed's dot plot update.

5yr Treasuries took last week's dot plot news harder than 10yr Treasuries and much harder than 30s.  That said, they are still inside the trading range of the last 3 months whereas 2yr yields are at the highest levels since the initial free-fall at the start of the pandemic.  

All this to say that today's 5yr auction is a bit of conundrum for traders seeking to get inside other traders' minds.  Is a strong 5yr auction a win for the long-end of the curve or is it a vote against the quick burst of flattening seen since last week (i.e. a win for the short-end)?  If I had to pick a side, I'd say the 5yr definitely behaves more like the longer-end of the curve.  Perhaps even more importantly, the average mortgage tends to last roughly 7 years, so the 5yr note is especially relevant for our purposes.  Bottom line: what's good for the 5yr should be good for MBS.