The relationship between short and long term yields is an important indicator for bond markets and the broader economy.  10yr yields are almost always higher than 2yr yields, but when they become much closer together, or when 2yr yields actually rise above 10yr yields, conventional wisdom holds that recession is in store.

With 10's trading around 1.75 and 2's around 0.8, we're nowhere close to a so-called "inverted yield curve," but the  gap has grown relentlessly narrower since the beginning of 2014.  Any time the yield curve is narrowing this much, and especially when it's breaking below 1% (as it is now), investors begin wondering how far away the next recession might be.  

This yield curve flattening is the first warning in the short term bond market, and one that's worked largely to the advantage of longer term rates.  After all, impending recessions generally aren't good for long term rates.  A tightening yield curve has also been consistent with falling longer term yields over the past few years.

2016-2-29 curve

The second warning cuts the opposite direction.  It stems from the fact that a 10yr yields don't historically track the shape of the yield curve like they have been in the chart above.  In fact, the "QE era" beginning in 2009 is the only great example of such a strong correlation.  It requires a combination of an uncertain economic outlook along with central bank policies that keep short term rates depressed.  In other words, if 2yr yields are held near zero (as they had been for the past 5 years, the yield curve (relationship between 2s and 10s) will correlate almost perfectly with 10yr yields because 10yr yields are the only thing moving. 

Now that 2's are moving again, the risk is that further upward movement can create upward pressure for 10yr yields as well.  This has always been the case in the past, although ahead of recessions the impact of rising 2yr yields is limited (obviously, if they've actually risen to higher yields than 10's).  Still, from a shorter-term standpoint, we may have just witnessed a mere correction in the trajectory of 2yr yields following the December rate hike.  

In other words, 2yr yields spiked higher than their previous trend would suggest and the first part of 2016 runs the risk of merely being the time when 2yr yields returned to that trend.  If that's the case AND, importantly, if we're not on the doorstep of a recession (a big "if," depending whom you ask), that upward pressure can still translate to upward pressure on longer-term rates like 10's and mortgages.  If it does, the following chart is a bit scary.

2016-2-29 2yr

Of course the bullish case for rates is that the world is screwed, economically, and that these historical correlations tend to break down at such times.  Central bank QE (in Europe, particularly) has already led to such a breakdown in 2014 (the year the world priced in the ECB QE that was ultimately enacted at the beginning of 2015).  At this point though, it takes more QE to keep the traditional correlation from presenting challenges for the 2016 rally. 

With all of the above in mind, anticipation over next week's ECB announcement could overshadow domestic economic data this week, to some extent.  Don't expect markets to completely tune out though.  This is the biggest week of any given month, with the ISM manufacturing and non manufacturing reports, as well as ADP Wednesday and NFP Friday.

MBS Pricing Snapshot
Pricing shown below is delayed, please note the timestamp at the bottom. Real time pricing is available via MBS Live.
FNMA 3.0
102-14 : +0-02
10 YR
1.7550 : -0.0090
Pricing as of 2/29/16 9:10AMEST

Tomorrow's Economic Calendar
Time Event Period Forecast Prior
Monday, Feb 29
9:45 Chicago PMI * Feb 53.0 55.6
Tuesday, Mar 01
10:00 ISM Manufacturing PMI * Feb 48.5 48.2
10:00 Construction spending (%)* Jan 0.3 0.1
Wednesday, Mar 02
7:00 Mortgage Market Index w/e 521.5
8:15 ADP National Employment (k)* Feb 190 205
9:45 ISM-New York index * Feb 718.9
Thursday, Mar 03
8:30 Labor Costs Revised (%) Q4 4.6 4.5
8:30 Productivity Revised (%) Q4 -3.2 -3.0
8:30 Jobless claims 4-wk avg (k)* w/e 272.00
10:00 ISM N-Mfg Bus Act * Feb 54.0 53.9
10:00 ISM N-Mfg PMI * Feb 53.1 53.5
Friday, Mar 04
8:30 Non-farm payrolls (k)* Feb 195 151
8:30 International trade mm $ (bl)* Jan -44.0 -43.4
8:30 Private Payrolls (k)* Feb 185 158
8:30 Average workweek hrs (hr)* Feb 34.6 34.6
8:30 Manufacturing payrolls (k)* Feb 0 29
8:30 Unemployment rate mm (%)* Feb 4.9 4.9
8:30 Average earnings mm (%) Feb 0.2 0.5