All that discussion we've been having on the unwillingness of MBS to participate in a geopolitical flight-to-safety is coming to an ugly head this morning.  Fannie 3.5s are struggling to hold even the most modest gains while Treasuries rally to 14-month lows. 

Here's a play-by-play of the overnight rally and early morning correction:

• Obama announces air strikes in Iraq, 10yr yields fall to 2.38 in Asian trading
• European trading opens and bonds rally more.  German bunds hit high 1.02% range.  US 10's fall to 2.349
• Market rout fizzles as equities were unwilling to go much lower, reversal was gentle at first.
• Then news hit just before 8am that Russia is ready to mediate talks between Kiev and East Ukraine.  The reversal picked up steam and 10yr yields were back up to 2.41
• The reversal has since leveled off and yields are back to 2.39. 

Through it all, MBS are underperforming horribly with Fannie 3.5s up 5 ticks compared to the 11 ticks of price gains in 10yr Treasuries.   Economic data is present, but largely unimportant today.  Bond markets are fighting battles based on jockeying of trading positions and technical levels.  Beyond that, they're in tune with European markets for the next few hours at least.

Bond markets were already doing fairly well, but got another jolt of positivity after newswires hit that a Ukrainian fighter jet was shot down over eastern Ukraine.  The market reaction is due to such headlines standing the chance to be the start of a war/invasion--a hot topic so far this week.

German Bunds fell to 1.06--another new all-time low--and Treasuries followed by breaking to levels not seen since late May.  10's are currently trading just under 2.44.

MBS have been lagging Treasuries both in the medium and short term--really, ever since the geopolitical risks stepped to the forefront in July.  All that to say that MBS are NOT at their best levels since late May, and they'd need to gain another half point to make that claim.

That said, they're still up 6 ticks, which is enough for positive reprice potential.

In addition to the European bond market strength overnight, S&P futures and other equities markets followed the move lower in bond yields overnight.  To a much greater degree than Treasuries, equities markets get a big injection of liquidity when cash trading opens at 9:30am.  Today's open has seen a sharp move higher with S&Ps already 8 points up from 9:30am levels.

Treasuries and MBS have lost ground as a result.  Fannie 3.5s are down 3 ticks from 9:30 and 10yr yields are up about a bp.    This isn't quite enough weakness to warrant negative reprice risk yet.  Even then, it looks like we have a chance to bounce here.  Too soon to tell, but so far, so good.  We'll let you know if that changes.

This isn't a negative reprice situation for the average lender, but certainly a heads up that the trend in bond markets has been moderately weaker since just after 2pm.  MBS have been under relatively more pressure than Treasuries with Fannie 3.5s back down to -0-03 on the day at 102-08.  They'd been as high as 102-13 earlier.

While the afternoon weakness doesn't necessarily connote negative reprice risk, it all but guarantees an absence of positive reprice potential (for those of you who might have been waiting).

After falling somewhat sharply after this morning's ISM Non-Manufacturing data, bond markets are bouncing back.  10yr yields are now back below pre-ISM levels and MBS are just now moving through theirs.  Fannie 3.5s are now down only 3 ticks at 102-09. 

This alleviates any negative reprice risk from earlier lows. 

Both of the 10am economic reports came in stronger than expected, and bond markets have weakened as a result.  Fannie 3.5s are at the lows of the day, down 4 ticks at 102-06.  10yr Treasury yields are up 1.8bps at 2.509.

Prices haven't moved low enough to suggest negative reprice risk yet, but that could be the case if we lose a few more ticks. Here's a run-down of the data

ISM Non-Manufacturing

• ISM PMI 58.7 vs 56.3, highest since December 2005
• Business Activity 62.4 vs 58.1, highest since Feb 2011
• New Orders 64.9 vs 61.2 previously, highest since August 2005

Factory Orders

• June Orders +1.1 vs +0.6 forecast
• June Durable Orders revised to +1.7 from +0.7

Given the strength of those reports, bonds are actually holding their ground remarkably well.  As we discussed in this morning's 'day ahead,' part of the reason may be that these reports are falling AFTER the NFP/GDP readings.  In addition, it could just be taking time for the full effects to be felt in slower, summertime trading.

Trading was fairly quiet in the overnight session.  10yr yields held a narrow range between 2.51 and 2.49.  The weakest level were seen right at the start of the Asian session.  Bonds improved somewhat after weak economic data in China.

The biggest headline of the night was the announcement of a bailout for Portugal's troubled Banco Espirito Santo.  The bank's stock and Portuguese markets accounted for most of the market reaction, with heavily diminishing returns for the rest of the European bond market and overnight Treasury trading.

With the onset of domestic trading, the normal increase in volume and participation has been positive for bond markets.  Both MBS and Treasuries crossed the 8AM threshold unchanged vs Friday's latest levels, and both have improved since then.

Fannie 3.5 MBS are up 2 ticks at 102-12 and 10yr yields are down 2.15bps at 2.484.  There is no significant data on the calendar today.  The only game in town from a market-watching standpoint is to keep an eye on technical levels in Treasuries.  Things don't get serious for 10's unless yields approach 2.44 or 2.56.  It would be a surprise to see either of those broken today.