MBS CLOSE: What The Curve Says About The "Bond" Market

by Matthew Graham

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TOMORROW:

• NFP at 830AM
• Wholesale Trade at 10AM
• Consumer Credit at 3pm

Ok... Of course anything can happen tomorrow, and probably will, but at some point in the reasonably near future, a "quantum of solace" should show up to the party...  Not talking about your buddy bringing over their "Bond collection," but rather, our "collection of Bond" metrics is suggesting it's almost time to call our much anticipated FLATTENER (short term yields and long term yields become more similar) in as a missing person.

What does all that greek mean?  If short term and long term yields move closer together, either the long end goes lower, the short end goes higher, or something in between...  And although there's plenty of overhead room in short yields that can push the 10yr (and probably production MBS coupon yields) a bit higher, the current economic state of the "world is not enough" to incite a massive yield spike in the short end. But even if you can get on board with that, why the expected tightening of the yield curve?  The following chart is "for your eyes only."

So, you're looking at the 2's 10's curve back to 1980's.  The higher it is, the bigger the difference between 2yr yields and 10yr yields.   Let's just say not even at Casino Royale could you find many takers to bet against a moderation of the curve.  And with the recent FOMC statement, not even the Dr. No's and Peter Schiff's of the world can opine about significant short term inflation risk.  So although we know that the extended period of low benchmark rates will eventually die, The man with the golden policy statement's message was clear yesterday: it will at least live to die another day.

But the potential for surprises tomorrow never dies....  NFP has perennial license to kill the bond market in the event of an upside surprise.  And although this wouldn't necessarily refute the 2's10's argument, it could certainly knock the living daylights out of rate sheets.  But as long as the the historical suggestions of the 2's10's behavior pans out, there will soon come a time where Mr. "Bond" himself asks: "Do you really expect me to talk about a widening 2's 10's?" and he will be greeted with the answer, "No Mr. Bond, I expect you to Buy Buy Buy!"

well, at least buy a 10's 2's swap...  Doesn't mean rates get better, but it puts the pressure on the economy to stay exceedingly bullish or for the goldfingerers to start pointing to inflation, and fast.  Whatever the case, let's just hope those 2 previous peaks in 2's 10's doesn't turn out to be something that only lives twice. I say let the resistance live!  (and let die the tedious stock rally...). 

Back to reality for a moment, free from the bonds of my bond diversion...  Here is how the back up in yields has taken shape so far this week as weakness has continually ratcheted the 10yr yield higher, each time seeming to hone in on a desired range only to get bumped out shortly thereafter.  It was the same today as the range narrowed into what one might assume is the chair from which the bond market is finally ready to take the NFP news...  So reversal or just another step on that staircase?

Don't read anything into the ostensible reversal in MBS...  That price curve shoots down 11 ticks or so in the near future purely as a function of settlement, not to mention the extra reasons MBS have had to tighten over the past few days.   Focus more on 10's.  This is the main reason I've been harping on spreads today and yesterday...  The yield curve is likely to be more informative to MBS direction given the tightness of spreads and the passing of "supportive week."

Does all this mean: "don't worry about rates getting worse tomorrow?"  Not hardly...  It's more "big picture" perspective, and a backdrop against which to watch the movements of the short end versus long end of the curve.  As always, your best view to a killer analysis of all that is right here.