Bond markets are trying to find their footing this morning after yesterday's weakness extended through the overnight session. News that the ECB may go one step further than yesterday's bond-swap deal and actually allow Greek bonds to be written down in a similar fashion to the upcoming private sector haircuts prompted the move higher in yield this morning and lower in price . 10's approached 2.04 and Fannie 3.5 MBS 103-03 before bouncing a bit in recent moments.
The markets's focus is clearly on Europe. This morning's Consumer Price Index data was a relative non-event, as expected, and is certainly not motivating any of the current price action. Volume is following European headlines and European trading. To wit, the first pop higher about an hour before the domestic open came on the announcement that Italy's PM Monti, Greece's PM Papademos, and Angela Merkel were optimistic about a solution being reached on Monday after a 3-way conference call earlier this morning. Admittedly, that's lackluster news. The more meaningful surge in volume came shortly thereafter on the ECB news, and caused another quick 3bps rise in 10yr yields.
If the ECB allows Greek debt at central banks in EU states to be written down, it equates to another chunk of cash that can be considered when determining Greece's fate on Monday. It could help keep private sector haircuts in a more palatable range. In short, it just adds to the optimism that things can "get done" on Monday.
Now... More than a few market participants are saying "fool me once...," ourselves included. But current developments still have to be respected. There's no doubt that the ECB's decision to take these actions now, of all times, means something. We're not sure how big that "something" will be, but we do know that it arrives ahead of a 3-day weekend, with the big vote and PSI discussion taking place on the 3rd day. So even if we're not ready to take the bait completely, and jump on any "EU is Fixed!" bandwagons, it's a scary enough situation to warrant defensiveness (not to mention that there's auction supply next week).
Buyers are obviously interested in defending the 2.04 technical level in 10's, but trading up to a zone centered on 2.10 is very much on the table in the near future. That wouldn't really change our tune unless we subsequently started seeing mid 2.1's in high volume.
The conversation is clearly focused on Treasuries in terms of assessing technical levels. This is made possible by the fact that MBS are experiencing similar technical considerations, as they often do. Fannie 3.5's are also seeing potential support from a long term bullish trend and are also sitting right on long term horizontal pivot points. Granted 103-10 is a bit less long-term than 10yr's 2.04, but as you can see in the chart, it's still a fairly noticeable diving line for Fannie 3.5 prices.