If one were to look up a definition of range-trading in the Encyclopedia of MG and AQ's Frequently Used Market Jargon, there would not be a standard definitiion comprosed of words with any sort of traditional structure. Instead, there would simply be the following: 8/18/2009 Bond Market. Over the past few months (medium term), range-trading has been most frequently discussed in some context based on PAR. Additionally, even the shorter term fluctuations are often couched in this same guise. But in ostensible contrast, we note that MBS are at the mercy of the gyrations of the yield curve. So which is it? If we're so connected to the yield curve, why would PAR even matter? Wouldn't we simply cross right over PAR if that's where the yield curve was leading us? It turns out there are two right answers.
As the astute among you might notice, something is indeed different about the MBS chart. Today we've overlayed 10yr futures against MBS to show you that although MBS remains VERY much at the mercy of the yield curve, it ALSO has a mind of it's own when it comes to PAR-Nertia. This will end up supporting a "return to status quo" in grand fashion.
Point 1: Consider the overall connection of the two lines. They are right on top of each other almost the entire day. This point is evidence that their dollar prices are moving in concert aka "mercy of the yield curve." Today's overall market movements took their toll on fixed income with these futures contracts being the best-behaved representative for analysis. So we see, in general, "bond market sentiment" reflected in the blue line. From there, being at the mercy of the yield curve, for MBS, simply means that MBS prices are going to adjust to keep pace with the interest rate environment, fluctuating only inasmuch as the range of spreads will allow.
Point 2: Consider that there is one point in the chart that stands out like a sore thumb in terms of the lines diverging. Notice where it is? Precisely as MBS prices draw near to PAR! In a striking example of Par-Nertia--in fact, it borders on beautifully artistic--MBS REVERSE course smack-frickin'-dab on PAR while 10yr futures continue lower. Not only that, but they hold that wider comparative range for over and hour before finally capitulating to the yield curve's desires. AFTER that, it's right back to the previous uncanny connection.
We'll discuss the "why's" behind the significance of PAR in the near future, but for now, it's just good to be aware of the constant "status quo seeking" that continues to re-emerge even as reconnection to fundamentals appears to be taking shape. So FYI, it's STILL a trader's world... We're just living in it!
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