Bond markets had a great day today, but the greatness isn't entirely logical (ironic headline choice this AM, no?).  While there was some economic data supporting the rally--namely Jobless Claims and Construction Spending--other data suggested the opposite move.  Incomes/Outlays were stronger and ISM Manufacturing was no weaker than forecast.

If we want to look at the nice spike higher for MBS right after the 10am ISM data, and do so in the context of 'logic' and the overall economic data landscape, here's how we do it:

Weaker GDP dominated yesterday's trade and kicked off a bit of a chain reaction among accounts being forced in to buy bonds in order to close out previous short-selling bets (aka "short covering").  That made for a good amount of strength yesterday, but not as much as a normal pre-NFP snowball rally.  It's possible--given the gravity of the ISM data--that the 'shorts' were waiting for 10am, JUST in case ISM came in stronger than expected, in order to have a slightly more advantageous price when it came to to cover shorts ahead of NFP.

In other words, if I'm short interest rates 2 weeks ago, I say "OK, the 10yr is near 2.6 at a price of 101-10.  I'm selling now at 101-10."  That means that any time in the future, if I buy-back for less than 101-10, I make money. 

Now... the range since mid April is SO damn narrow, that we were much closer to the lowest prices in that range yesterday morning, but found ourselves quickly approaching the highest prices after GDP.  The higher prices moved, the more motivation for short sellers to buy.  The more short sellers buy, the more motivation for the next short seller to buy as the price continues going higher.

If I'm a short seller, I may well have been holding out for that ISM data as described above.  That even would have made me a small profit up until 9:57am.  There were probably many out there like me, and they were probably getting antsy as well.  As soon as that data hit and was clearly not strong enough to motivate major selling in bonds, EVERYONE in my same position rushed for the buy button to close out their short position. 

While we can't know if this explains all of today's surprising strength, it certainly accounts for some of it.  Tomorrow is completely up to the data, as always, but here at the best levels of the recent range, there's no denying the overwhelming gut instinct that risk of a pull-back seems much larger than the prospects for a weak number to take us significantly lower in rate.