Bond markets began the day on the back foot, losing ground right from the overnight session. The weakness didn't pick up noticeable steam until the onset of domestic trading where a palpable absence of Friday's positive factors made for a lack of buyers.
The end of May had been buoyed by strong buying in bond markets from money managers who are required to adjust portfolios to match the duration of bond indices. So-called "index extensions" provided a constant source of moderate strength through Friday and were complimented by demand from short-covering (traders who had bet on higher rates being forced to buy in order to cover their 'short' bet).
With those two benefactors understandably absent this morning, bonds haven't been shy about moving in the other direction. The only saving grace was the weaker-than-expected ISM Manufacturing report that came out at 10am. In a somewhat cruel twist of fate, rumors circulated and the ISM quickly confirmed that it had used the wrong seasonal adjustment factors in today's report and the correct numbers made for a STRONGER-than-expected reading.
With bonds having improved when they thought ISM was weaker, they naturally erased those gains when ISM "became" stronger. Even before that though (and before rumors began circulating), Treasuries and MBS had already bounced back toward unchanged levels, hinting at a certain measure of innate, preexisting weakness, independent of the ISM surprise.
All this having been said, it's a reasonable assumption that bonds are just flushing out the portion of last week's strength that may have been a bit over the top. To that end, 10yr yields are now back in the range that preceded the last surprise rally on Wednesday and Thursday. They're more likely to feel a stronger pull of gravity here. It's the same story for MBS upon Fannie 3.5s reaching the low 102-20's.
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