Sellers gained control of the bond market yesterday. This weakened the strength of supportive roadblocks and allowed benchmark yields to drift higher than they might have in a more balanced trading environment.

It appears fast$ short sellers have recognized this observation and are now taking advantage of it by covering their short positions, which effectively books a profit on a bearish tactical bias.  This is a rational move ahead of Fed Chairman Ben Bernanke's first visit to the now Republican-led House Budget Committee. 

Ben Bernanke vs. Paul Ryan. Cost Push Inflation vs. Demand Pull Inflation. The Budget Deficit! This is gonna be good! 10AM on CSPAN.

We are indeed seeing position squaring in the form of short covering in the "Rate Sheet Influential" belly of the yield curve. While not a sign of outright optimism for 3.70% support, this behavior does imply short sellers are naturally nervous about leaving profits on the table for too long.  We're indirectly encouraged by this but by no means are we excited. Snowball selling is still  just around the corner. We must hold near current levels or we fear more pain will play out in loan pricing.

Snowballing selling is a liquidative "duration shedding" phenomenon associated with extension risk in the bond market. Snowballing matters because it leads loan pricing sharply lower and pressures the "Best Execution" 30 year fixed mortgage rate rapidly higher. Snowballing selling is what we witnessed in early December. We haven't seen snowball selling in the post range break run up but we're definitely teetering on such a move. Hedgers are preparing by selling benchmark Treasuries and buying protective options. An avalanche of "duration shedding" would surely push the "Best Execution" 30 year fixed mortgage rate up to 5.25-5.375%....and it would happen in the blink of an eye.

This post explains extension risk and snowball selling in greater detail: Explaining Extension Risk Using Loan Pricing as an Example

Benchmark 10s are bid near our 3.70% target. FNCL 4.5s are +8/32 at 100-07.