In an overdramatized sort of way, Wednesday will be "do or die" time for bond markets in that 10yr yields must either finally break back below the important mid 1.86's or continue to confirm a trend of weakness (note: a majority of the following will focus on 10y Treasuries, both because the 10yr auction is today's primary source of guidance and because 10's are a superior technical benchmark vs MBS when markets are moving directionally, especially when MBS are about to move through their monthly roll on Thursday afternoon).  Even if the latter proves to be the case, the dying wouldn't necessarily be quick and painful, especially not with unresolved debt-ceiling issues yet to come.  The current era of exceptionally low and sideways rates should continue to be prepared for the time when we're definitively trending higher in rate, even if that trend only represents the slow and painless death of the low rate dream.

Too dramatic?  hardly.  We're not suggesting that bond markets never return to December's levels--simply that trading levels have been making a case for big picture reversal at a modal low of 1.55 in 2012.  It's still quite possible that we'll see lower yields than that in 2013, but it's also possible that a long-term floor is already behind us.  What happens over the next three months will be a big help in determining that.

As far as today's "do or die" time is concerned, note the horizontal teal line in the following chart.  With very few, very brief exceptions, it's been the dividing line between the past 7 months and the past 7 days.  The red lines represent one potential trend that's been pushing back against fairly low levels in November and early December, ultimately convinced to head north after December's NFP, helped along by the FOMC announcement and debt ceiling debate.  

The upper limits of this negative trend were tested after last Friday's NFP, but it's interesting to note that it was only intraday time spent outside the trend with Friday's closing levels ultimately falling back under the red line.  If we fail to move lower in yield on Wednesday, then we'll have to continue to consider the potency of the 1.865 inflection point, but if we manage to break lower, we can then turn our attention to combating or confirming the longer term uptrend.  That battle is still very much up in the air, but let's hope we get a chance to fight it by making it down through 1.86 first.

Today brings the important 10yr Note auction at 1pm and apart from MBA mortgage applications in the early morning, that's really it.  The Fed will be in conducting "Twist" buying from 10:15-11:00am in the 25-30yr range, but the focus should be on the 1pm auction.  As has been the case throughout the tumult, we'd continue to expect MBS to mirror and match movements in Treasuries, but perhaps with decreasing flexibility heading into Thursday's roll.  That means that MBS should do a better job of holding their ground into a sell-off and lag behind in the event of a rally.