Last Week

- MBS began week in "relief rally" following previous week's NFP

- NFP was strong, but bond markets were prepared for worse

- Relief rally ran its course by Tuesday PM; Most losses seen on Wednesday

- Perfectly flat from Wednesday's close through Friday

- Data and events were shunned yet again in favor of FOMC positioning

This Week

- FOMC Wednesday at 2pm Eastern dwarfs all other events

- Wednesday also brings 3 months of Housing Starts data

- Another Treasury Auction cycle begins Tuesday

- Potential size of movement limited only by extent to which Fed deviates from game-plan

Strategy

Exhaustion was evident in last week's bond market trading.  We discussed that "year-end exhaustion" quite a bit in this post.  To make a long story short, trading levels did less to react to the data and events of the past week and more to get in position for various outcomes of this coming Wednesday's FOMC Announcement.

Stepping back for a wider view, we see rates simply grinding higher into an increasingly narrow range (see chart below).  This week's Fed Announcement has all the potential in the world to break that range on either side, but the moral of the story is that this is general direction we should get used to in rates until and unless something big, new, and unexpected happens to change it.

Although the Fed dominates the week, there are other events on tap, though nothing of extreme interest.  Wednesday morning's Housing Starts data will make up for the past two months without data.  That would be more meaningful had we not been privy to Building Permits numbers already.  A GDP revision is out on Friday, but market participation will likely wane quickly on the last two days of the week.  That makes the reaction both unpredictable and less consequential.

Charts

The white line in the chart of 10yr yields below is arbitrarily drawn, but it's essentially the central tendency from the 2013 sell-off blended with the central tendency from the mild 2012 selling pressure.  If you like, you could think of this as a target for negative bond market momentum.  Spring 2013 was getting off track, but brutally corrected in May and then overcorrected in June (FOMC) and July (NFP). 

The Fed counteracted the overcorrection by foregoing tapering in September.  The post Government-shutdown momentum took yields almost equally as far in the other direction before the November sell-off began.  This time around, the selling has been much more calm and mechanical (with one 5-minute exception following the most recent jobs report), and brings yields almost perfectly back to this long-term central tendency. 

That leaves the door more open for the Fed to go either way at this meeting and decreases the chance that we'll see a majorly positive or negative surprise.  In other words, if they taper, it'll be on the small side of expectations.  If they don't taper, they'll make sure we know it's coming.