The dollar is weaker, commodities are more expensive, and stocks are suddenly back in style. Consequently, the market's appetite for risk has given TSY traders an opportunity to push TSY yields a few bps higher ahead of this week's $71,000,000,000 auction cycle. (I hope the zeros add some perspective)
While stocks attempt to recover recent retracements, the 10 yr TSY yield has been pushed closer and closer to its summer long range resistance....3.27%. BOOOO RIGHT?
Although benchmarks are testing the durability of the recent RANGE BREAKOUT, "rate sheet influential" MBS coupons are holding up just fine (for now at least). Currently the FN 4.0 is -0-04 at 99-13 yielding 4.0687% while the FN 4.5 trades 4/32 lower at 101-20 yielding 4.3004%. The secondary market current coupon is 4.127%.
Although, this sounds like a loss of all recent RANGE BREAKOUT progress....its still only a psychological obstacle. We call it that because today's higher rates are really a function of bad timing and a slow news investing environment, not a shift in BIG PICTURE sentiment. (for now at least)
Plain and Simple: nothing monumental has happened between today and late last week that would warrant a fundamental shift higher in benchmark rates! The domestic calendar has been empty!
Higher TSY yields and RED MBS price changes are a factor of bad timing. Globally, stocks have benefited from news that Australia had unexpectedly decided to increase benchmark borrowing costs. Strength in stocks combined with scheduled TSYs auctions have provided benchmark debt investors an opportunity to force yields off 5 month lows...aka...an opportunity to earn greater returns (at least relative to last week) in the risk free debt market.
Some observations ahead of the 1pm $39,000,000,000 3yr note auction....
Today's auction supply is in the short end of the curve. Thus, one might assume that issuance in the short end would bring about WEAKNESS in shorted dated TSY debt today....meaning...one might believe the yield curve would flatten as longer dated TSYs outperform shorter dated TSYs (today). HOWEVER, given the extent and speed which the yield curve has flattened in recent weeks (long end rallied more than short end)....the long end is due a correction! Which is one reason, combined with the maturity of the rest of the debt to be auctioned this week, why we said last week that we thought rates would rise a few bps this week....because we thought the yield curve would steepen, we thought the short end of the yield curve would outperform the long end.
BUT, the Yield Curve is not steepening to the extent that we thought it would ahead of the auctions...not yet at least. This is not a function of the auctions...its more a result of Australia increasing rates overnight. NOTE: we do not think the US Federal Reserve will raise rates until the labor market stops contracting...and then proves that is has stopped contracting via consecutive months of jobs growth.
So while our bias towards a STEEPER yield curve has not played out as much we had thought it would...this doesnt mean it wont occur in the near future...perhaps as soon as 1pm when TSY auctions $39billion 3 yr notes.
The nitty gritty you need to take from this is..
- TSY supply/auctions, a lack of econ data, and the stock lever are influencing mortgage rates.
- The yield curve is not steepening as much as we thought it might ahead of the auctions because of news from Australia
- Even though China is out on holiday, we dont think it will play a major role in the demand side of the auction equation.
- Auction results should illustrate a continued global demand for risk free assets (ugh...we hope)
- WE DO THINK, given the sell bias in the rates market, THAT WHILE DEMAND WILL BE DECENT...IT WILL ONLY BE AT HIGH YIELDS.
- After the auction I expect the yield curve to steepen. I expect the long end of the curve to be outperformed by the short end ahead of $20bn 10yr notes and $12bn 30 yr bonds.
- This means I think the 10yr may break 3.27% by days end...which would result in lower MBS prices and possible reprices for the worse
That's our gut feeling people...
THE WILD CARD: The Stock Lever. What's bad for stocks will be good for bonds.
THE WILD CARD: auction concessions have already been priced in and better than expected results keeps the 10yr yield close to the 3.27% technical fence?
The When Issued 3yr TSY note is trading at a yield of 1.435%
PS: I hope we are wrong
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