MBS CLOSE: More Of The Same

by Matthew Graham

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Pete Townshend certainly seemed like he was confident about something in one his more popular songs...  Perhaps when we ask ourselves "Who" knows what's going on in the markets, the answer is ironically close at hand.  But even if we can't get Pete on the line to field MBS questions, hopefully in conjunction with our previous discussions on The Trader's World, you too will be able to confidently declare "won't be fooled again!"  Or more appropriately, at least be able to expect the curveballs, understand their causes, and make adjustments to maximize profitability in their presence. Where am I going with this?  Read on...

You might see your first indication of where we are going with this by looking at the 2 day chart in MBS, tsy's, and stocks.

Yes, there are indeed similar patterns over the past two days.  In each day we have fixed income improving in the AM as stocks sell.  Post-auction saw similarly viscious little spikes in tsy yields followed by gradual improvement into the close.  Whereas yesterday's walk into the sunset (2pm-5pm) was range bound today's got a beneficial jolt from the beige book that sent yields a bit lower from the course they were on.

As you might expect if you're a frequent reader here, MBS spreads widened into rallies and tightened during sell-offs.  Thus, both the AM sessions yesterday and today saw progressive widening follwed by big-time MBS outperformance for a few fleeting moments before falling right back in line with previous levels.  Hmmm....  Exagerated movement in each direction that ultimately returns to the original path...  Where have we seen that before....

You remember yesterday's close?  More of the same today as we end smack dab in the same range of uptrend that began the week.  I'm not trying to talk about technical analysis so much here as to simply say that we entered the week with a general sentiment, a general position, and a general expectation of the auction results.  The teal circle tells you that average sentiment trend that began this week was fairly well aimed despite auction related convulsions.  This tells you that concessionary selling did a good job of baking in the somewhat negative auction results we've seen.

Could this then mean that the 7 year auction tomorrow has already been given permission to be worse than expected without it having a major effect on bond markets?  Sadly, no...  It would have to be in a certain sweet spot of weakness that, although noticeably discernable as such, is not so weak as to cause panic.  Furthermore, with today's auction ostensibly more important than the 2yr, we likely needed that extra "boost" from a lackluster print on Durables and underwhelming beige book.  So although it's entirely possible and does indeed seem to be the underlying range of short term sentiment, such ranges are prone to adjustments in dangerously short time frames.  Better then to take a look at the psychology behind the broader trends...

Longer term we see the post-panic new world order for 4.5 MBS has been range-bound trading between 99-00 and 101-00.  There is no clear indication of impending direction from the long term range since we're near the mid-point.  On the other end of the spectrum is the short term uptrend within the yellow lines.  This is the same gradual uptrend we just discussed on the intraday chart.  Just as the long term trend is a bit too broad to be of use to us, the short termer is too narrow. 

The warm bowl of porridge is the medium term consolidationThe teal lines show two competing trends: the more mature uptrend beginning with the lows in mid June and the less mature but more recently tested downtrend beginning with the high near 101-00 in early July.  Why so warm?  It's a happy medium of being close enough to it's trend lines that we have a good chance to test them soon, but it's far enough away from those lines that we don't have to worry (as much) about it being too narrow to be statistically significant.  In other words, changes in trend occur less and less frequently the longer the time frame.  So we need to look at a narrow enough time frame that prices are actually close enough to breaking a trendline that they will actually tell us something.  Going any more narrow than that increases our chances of volatility and (obviously) decreases the length of time the trend has been established.

So it's with that we arrive at the happy medium here, and as you can see, she's running out of room.  As always, nothing's definitive on a breakout, but statistically, we'd be more likely to test higher resistance if we break out on the topside and vice versa for a downside breakout.  Incidentally, If I were to go back in and tighten up my trendline handywork on the chart, it would be more apparent that IF a topside breakout happens in the next few days, it would likely be right around PAR.  Getting a breakout over par, and holding over par the next day would be an even better sign the riding the triangle out to the very end and only breaking out the topside at 99-30 for instance, as it would indicate more gravity defying momentum as spaceship MBS mounts yet enough attempt to overcome par-nertia.

But for now at least, it looks like we're heading right back into the event horizon.  Too bad that movie wasn't quite as popular as The Who or else I wouldn't have to worry where tomorrow's material comes from...  Tune in tomorrow for Jobless Claims, Fed MBS Purchases, and everyone's favorite, another treasury Auction at 1pm!  Everyone run the same routes as the last two plays!

MBS, Tsy, and LIBOR Prices