Short Covering Snowball Rally Pushes Treasury/MBS Prices Much Higher
We've been talking about 'short-covering' quite a bit over the past few days and it continues to be a factor in the positive and paradoxical NFP counter-attack (i.e. bond market rallying despite stronger NFP on Friday).
We've also been discussing the limited trading motivations inherent at the start of this week, leaving traders to observe and react to other trade flows and technical levels. We're in a situation now where both the tradeflows and short-covering are feeding on each other.
On one side, trades based algorithmically ("algo trading") on technical levels are subsequently triggering short positions to cover (i.e. forcing them in to buy bonds, thus covering their short). As those shorts become buyers, prices advance further, creating new technical levels for algo traders to buy.
Long story short, it's like a 2nd grade soccer game. Everyone is following the ball and the ball is moving toward one side of the field. The ref will probably blow the whistle before 10yr yields break past 2.75 and we're already seeing resistance at 2.80, but that's still made for a solid 5.5bp drop so far today.
MBS, for their part, don't get to participate quite as much because there's no inherent algo trade, and less liquidity than Treasury futures (which is where the Treasury algo trading takes place) overall. Fannie 4.0s are still up 10 ticks on the day at 103-27.