By the end of this long MBS Commentary post, you'll see that all the MBS/Treasury trauma in May was already laid out by Bernanke on March 20th.  Today's FOMC events will now simply be a chance to determine how closely they stick to this script.  Keep re-reading this until May's ridiculously brutal sell-off in bond markets is no longer confusing or a source of indignation.  It was a source of indignation for me as well, and in the struggle to "make sense" of everything that was going on around me, and in MBS spreads, I too kept re-reading until I figured this out.  Let me know what you think (unless you disagree, in which case, keep re-reading).

Today is all about the Fed.  The official FOMC Policy Statement and the quarterly staff forecasts will be released at 2pm and Bernanke will follow with a press conference at 2:30pm.  The net effect of today's events has the potential to confirm a long term inflection point for interest rates.  While this wouldn't necessarily mean that 10yr yields would never return under 2%, for instance, it could make that more challenging in the short term.  Think of it as a "vote" in favor or against moving back below that inflection point based on the information we have available today.  Lots COULD happen to change the rates landscape in the future, but these seem like the stakes for now.

Thankfully, the Fed has already dropped massive clues as to what we're about to see/hear.  Specifically, Bernanke's press conference back in March was a treasure trove of conditions, consequences, compulsions, and considerations.  In other words, he already said what would happen!  It's highly likely that the weakness in rates markets we witnessed in May has almost everything to do with the concepts laid out back in March. 

For over a month, Bernanke's March 20th treasure trove lay dormant in terms of its market moving potential.  At that time, rates were in the process of falling from the highs of the year and Cyprus was in the headlines.  Suddenly, the convincing long-term uptrend in rates didn't look so convincing any more and Bernanke's press conference comments were dismissed as something markets could revisit if they ever sounded less silly. 

March's NFP (reported April 5th) had markets completely convinced that Bernanke's thoughts were not only premature, but not even remotely relevant!  Furthermore, the Chairman's comments were muddied by the inclusion of Treasury remittances and Fiscal policy.  It was the apex of the Fed vs Congress political rhetoric and only in hindsight did these comments take on their true market moving potential.  Taken together with the other comments about "adjusting the pace of purchases" (which was totally premature, right?!), the whole press conference was easy to dismiss.  If it meant anything at the time, markets didn't have the right kind of decoder ring to understand it.

Unfortunately for low yields, April's Payrolls report on May 3rd provided the decoder ring.  Suddenly, Bernanke's March 20th press conference was a relatively apocalyptic prediction for interest rates, even if it took more than a week for Markets to start acting like it and the better part of a month for panic to be priced in.  That makes today--like May 22nd FOMC Minutes--much more about waiting to confirm that which has already been said.  In essence, we're waiting to see if the Fed will actually adjust policy according to Bernanke's March 20th road-map. 

Here's a step by step 'proof' that March 20th comments have been "the script" for everything that followed.  Reuters original newswires from March 20th's press conference are in all-caps with translations below (some of the translations have inner monologue in parentheses.  There's intentional humor there, but all in good fun.  It's intended to make the concepts most tangible and not to slight The Ben, in any way.  No one can impartially judge the Fed's decisions without many more years of reflection.  Even then, we'll never have an alternative to go back in time and experience.  Things in the mortgage market were pretty scary in 2008, and even normally savvy market-watchers were oblivious to the magnitude of the problem.  Bernanke wasn't).

BERNANKE -A NUMBER OF MY COLLEAGUES' ARE CONCERNED ABOUT FINANCIAL STABILITY

BERNANKE - THERE WAS A THOROUGH DISCUSSION OF RISKS AND COSTS OF ASSET PURCHASES

- "I know some Fed members have been vocal about huge risks associated with QE, but those risks are now a growing concern for mainstream Fed voters."

BERNANKE - ASSET PURCHASES ARE AIMED AT INCREASING NEAR TERM ECONOMIC MOMENTUM

-  "QE isn't meant to be a permanent crutch for the economy.  We're pulling the starter; pushing the car; treating the patient; etc..  But once those efforts 'take,' well...  I guess I'm not saying what happens after near term momentum is established, but since that's the goal of asset purchases, obviously 'whatever happens next' won't be 'more asset purchases.'  Perhaps I'll speak to this in another bullet point further down the page.  (Oh man... I am not looking forward to trying to define and pinpoint 'near term momentum.'  But they're going to wonder how they can tell if we're there yet.  Maybe I can speak to the fact that it's not easy to put a threshold on the QE piece of the equation...)"

BERNANKE - WE HAVE NOT BEEN ABLE TO GIVE QUANTITATIVE THRESHOLDS FOR ASSET PURCHASES BECAUSE ASSESSING RISKS IS COMPLICATED

- "It's not easy to put a threshold on the QE piece of the equation.  Not only that, but I know what a big deal this is to trading volatility because QE amounts to guaranteed cash flows that automatically price in to lower rates, so I gotta be really careful of what I say and what conclusions traders will jump to based on economic eventualities.  (Hopefully NFP will suck in April and buy us some more time here.  Woo boy!  If that happens, then only a cataclysmic upward revision on May 3rd will land my butt back in a sling with these vultures.  Even then, I'd have plenty of time as long as no one re-reads the rest of the comments I'm about to make)."

BERNANKE - CROSSING ONE OR MORE OF THRESHOLDS WILL NOT AUTOMATICALLY LEAD TO RATE HIKE

- "I know we have that 6.5% thing in the statement, but that was just our hastily conceived way to back the calendar date verbiage out of the official text.  I don't know how we'll back this troublesome threshold thing out yet, but it doesn't really mean what it says because labor markets are way more complicated than the U/E number, even though what we actually say in the statement makes it seem like that's the lynchpin. (Wow... now that I say that out loud, it really seems silly...  I hope they can't tell that the threshold introduction was further evidence that we're increasingly concerned about risks associated with easy policy.  I better throw in that other stuff too so they know what else we'll be looking for...)"

BERNANKE - WILL BE LOOKING FOR SUSTAINED IMPROVEMENT IN PAYROLLS, JOBLESS RATE, JOBLESS CLAIMS, QUIT RATES

- "Here's some other stuff that we'll be considering in addition to the one thing that actually appears on the policy statement.  Either it was too complicated for Main Street to understand or we totally realized how hasty it was to ONLY put U/E in the policy statement. (Ha ha... I bet they'll be chewing on that "sustained improvement" business...  That'll be nice to have in the hopper.  We can always come back and say 'improvement' just means 'enough to lower U/E.  Wait... They don't like that vague stuff, so I guess I'll just say the following).

BERNANKE - WE ARE SEEING IMPROVEMENT IN LABOR MARKET

- "that which we have already seen = improvement.  HENCE: "MORE OF THE SAME = SUSTAINED IMPROVEMENT!!!!!!!"  (There's no possible way they can still be debating this if the next three jobs reports are as good or better than this one, right?  Oh wait.. they might be confused if the U/E rises...  I better leave them a clue to let them know that U/E increasing is only likely to result from an unexpected increase in the labor force.)"

BERNANKE - BECAUSE OF DEMOGRAPHIC TREND, DOUBTS THERE WILL BE AN INCREASE IN LABOR FORCE PARTICIPATION RATE IN NEAR TERM

- "U/E increasing is only likely to result from an unexpected increase the the labor force."

BERNANKE - FED MAY ADJUST RATE OF PURCHASES MONTH TO MONTH TO CALIBRATE HOW MUCH ACCOMMODATION IT IS PROVIDING

- "Boom!  Yeah, it's March 20th right now, and I just said that.  Bet you thought tapering wouldn't come up until after that May 3rd Freaky Friday NFP beat that I was hoping wouldn't happen."

BERNANKE - AS WE MAKE PROGRESS TOWARD OBJECTIVE OF SUBSTANTIAL IMPROVEMENT, MAY MAKE ADJUSTMENTS IN PURCHASES

- "I know I just said we'll be looking for 'sustained improvement,' but just in case the tapering thing freaked you out, the improvement also needs to be substantial."

BERNANKE - WILL PROBABLY NOT MAKE ADJUSTMENTS EVERY MEETING

- "just in case that freaked you out, and to build the sense that this isn't happening based on a predetermined schedule, once we start tapering, we might not do it consistently.  Also, I'm calling it "adjustments" for now, though will probably adapt to "reductions" or something when it becomes more clear that I have no intention of buying more than I am now.  I know you wouldn't be able to handle that info just yet, so I'll hit you up when the time is right."

BERNANKE - WILL ADJUST PURCHASES ONLY WHEN CONDITIONS HAVE CHANGED IN A MEANINGFUL WAY

- "Just in case that freaked you out, I'm really going to set the bar intangibly high.  I'm also going to hope that May 3rd NFP doesn't force my hand on this.  Worst case scenario would be for April 5th NFP to make it look like the labor market is hurting badly only to have May 3rd revise April 5th's print higher AND offer up a new headline in the same territory.  Why... Why that'd be just plain awful, because not only did I just say that "we're improving now," and not only did I just say we're looking for that improvement to be sustained, but I'm also about to say these next few things, which will really put the nail in the coffin of full-fledged QE."

BERNANKE - MUST MAKE SURE THIS IS NOT TEMPORARY IMPROVEMENT and IMPROVEMENTS MUST BE SUSTAINED FOR A NUMBER OF MONTHS

- "yeah, so basically we're going to be tapering if we hit June and still haven't dipped below current levels of job creation."

BERNANKE - TIGHTENING OF CREDIT IN MORTGAGE MARKETS HAS GONE TOO FAR

- "Higher rates will help loosen lenders up by forcing them to lend to the borrowers their overlays shut out of the game when rates were low enough that they could focus on the cream of the crop.  Very clever plan lenders!  Storing the low credit quality files as a preserved jerky for you to snack on when rates finally move higher.  I have no qualms about raising rates now, so you're forced to assist the underserved masses. (Hmmm... how to raise mortgage rates disproportionately?  I know!  I could just say something about 'desire to get back to Treasury portfolio.'  No way these cats and kittens are ready for me to lay it down like that just yet though.  Gonna save that one for May 22nd in case May 3rd NFP does that crazy crap I hope it doesn't do."

10yr Treasury chart of the time-frame discussed:

1. note that rates were hesitant to break below 1.84 until it looked like all the above Bernanke comments would be rendered "way too soon" by Jobs numbers in early April

2. note that rates IMMEDIATELY bounced back to 1.84 level in the week after the May 3rd employment data.

3. note the insane difference in the candlesticks from the following Friday (Hilsenrath article).  This is the visual incarnation of markets coming to terms with the fact that Bernanke's March 20th road-map was suddenly 'game-on!'  Volatility into higher rates was only natural as markets wondered "was he serious about that stuff?"  Not to mention the arguing and rationalizations that tapering wasn't remotely justified.

4. note that the FOMC minutes on May 22nd confirmed "yes, he maybe WAS serious about that stuff!" and the ensuing scramble of even more volatile volatility.  It looks significant that 2.07 had been a supportive ceiling, that it was tested the day after the Minutes, and that it only held up as a ceiling due to the impending 3.5 day weekend (in other words, participants assumed 2.07 support was in and they could check out for the weekend.  Tuesday morning was a rude awakening.  2.07 might have held, but with auction supply that week and NFP the next week, the massively better-than-expected Consumer Confidence data only needed to give yields a nudge higher to spook the whole herd.  Spook it did...

(to be clear, Confidence numbers didn't cause early June trading conditions.  The herd was already at risk of running that way and this just happened to be first convincing push, first thing on the first morning back from summer vacations)