For the purposes of this discussion, 'interest rates' refer to mortgage rates and 10yr Treasury yields. Why 10yr yields? I just put together this knowledge base article to answer that question (which I know would be on my mind if I were to see such frequent mention of 10yr Treasuries on an MBS site). Rest assured, we'll actively discuss MBS-specific charts and trading patterns if they happen to exhibit even a 10th of their previously boisterous personality. To see what I mean by that, just consider the following chart that shows the spread between MBS yields and 10yr yields (and the fact that there were individual DAYS in 2008 that moved more than the last 8 months).
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With that out of the way, what's all this about the brief history of interest rate movements?
Things have been a bit crazy in bond markets of late. At least it feels that way relative to a very boring February-April. So on the chance it's a useful recap of the last few months of relevant details, here's a chart of 10yr yields with some numbered sections. The numbers will be annotated below. Be warned, this is a gigantic wall of text that you may well not have time to read or the desire to understand, but even if you don't get around to it until this weekend, it's a good one to actually read and internalize (as opposed to skim for relevant nuggets). If you have questions in that regard, just ask.
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1. The first bullet point is more for context than anything, and largely because it was the last major run-in with the important 2.47 technical level (the fast-paced movement was a result of the Government Shutdown, by the way). In a nutshell, once yields rose above 2.47 during the 2013 sell-off, they never made it back below until this week, and October was the last time they came close.
2. These were the most recent yield highs, roughly matching those seen a few months earlier, but officially the highest in more than 2 years. We now know that trader positioning combined with holiday illiquidity to cause an overheated sell-off. A 2014 bounce back was already in the works whe...
3. ... a crappy jobs report sealed the deal, giving pause to the notion that rates HAD TO go higher in 2014. "Fine, fine, fine," thought bond traders, "but we all know rates are destined to move back over 3% some time soon."
4. The overconfidence in the impending move higher in rates among a big contingent of market participants made for too many traders on one side of the market. To make matters worse, stock positions were having the opposite problem--unable to break into new highs in 2014. Additionally, "risk-on" trading resurfaced with an eye toward Japanese Yen, European bond markets, and Chinese economic health. It was a bit of a perfect storm for a short squeeze (i.e. too many bond market traders betting on higher rates instead being met with lower rates and forced to cover those bets by buying bonds, thus moving rates lower and forcing more of their brethren to buy more bonds). January 23rd struck the match on that powder keg, but the fire kept burning through month-end index extensions (money managers being required to buy a certain amount of bonds to match the duration of their portfolios with various Indices).
5. January was like a big sneeze after you try to hold it in unsuccessfully. With the new month, bonds were ready to try this "ugly sell off to 3% 10yr yields" thing again, but for 3 months in a row had big problems trying to make it over 2.80%. The jury may have still been out on that until March's NFP numbers (which came out in early April), because clearly, markets turned on a dime on April 4th, so it had to be NFP, right? Well, maybe... It could be that markets were hoping for a stronger showing than the 192k print, but I took a different route with that night's recap (read it here, it's about how the European Central Bank began modelling the QE program that's about to show up in point number 7!).
6. Kicking off this little section of narrow trading ranges was one of the most miraculous days in bond markets I've ever seen. That was the NFP report that was MUCH stronger than expected, but on a day that managed to end in positive territory for bond markets. It was truly amazing. Bond markets were utterly paralyzed for the entire following week, never closing outside a 2.59-2.62 range.
7. The week after that was when the ECB's gloves came off. Draghi finally lost his temper and really let the cat out of the bag regarding the ECB's intention to ACTUALLY DO SOMETHING this time around instead of talk talk talk, promise promise promise. Markets took him seriously and 2.57 was finally crushed. During those two days, we would see just how many of those bond traders betting on higher rates were still around. Quite a lot, it turns out, and luscious juice of another bond market short squeeze flowed freely into the street. The following week was the run-up to Memorial Day Weekend, and apparently it was an unannounced week off for bond markets. I didn't get the memo, unfortunately, and still wrote up market movements every day before realizing there were none (to be fair, I did comment quite a bit on light holiday-related participation, but damn... it was VERY quiet in retrospect). The one important thing that happened from a technical perspective is that 10yr yields approached 2.57 from below and didn't break it. That was encouraging.
8. It's been hard to be too encouraged about any bond market rally after being so brutally conditioned during 2013, but maybe that's just where they want us! It was easier to be encouraged on Wednesday when 10yr yields broke below 2.47 for the first time since passing it coming the other direction in 2013.
9. Even into yesterday morning's push to 2.402, there was still an eye-watering amount of short-squeeze going on, but this time some of the strength was intentional buying (rather than forced buying) from accounts opting to get month-end buying needs out of the way before month end--not that uncommon. Still, tactical traders piled in to the early morning rally, and everyone else in the bond market looked at one-another and understood that wherever this buying was coming from (short-squeeze, opportunistic leveraged trading, month-end buying, who knows), that the good times were likely to keep rolling at least through the end of the Fed's daily buying operation. As soon as that was over, so was the party. When the non-short-covering demand stepped back from the line of bond buying, there were far fewer shorts being squeezed than thought. Bond bulls tried to hold on for a post-auction rally, but no buyers showed up despite a strong auction. Now the opportunistic buyers from Wednesday's rally were faced with rising yields and the prospect that not only was the short-covering demand potentially drying up, but also that some of the day's strength was month-end demand that would have otherwise shown up today. As such, they scrambled to book a profit (by selling) and less liquid afternoon conditions magnified the moves.
Where does that leave us today? Crazy snowball rallies are less of a possibility with less of a potential short squeeze in the works. Month-end buying remains to be seen, but if there was indeed a meaningful amount of it yesterday, that's another card in the deck stacked against us. From there it would be up to the economic data to speak loudly enough to motivate trade, and it's not yet entirely clear that it's up to that task. If any of the reports are, it would be Chicago PMI at 9:45am, but only if it's significantly weaker than expected. If we're on the ropes today, important technical levels include 2.484, 2.504 and 2.55.
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