After a relatively uneventful overnight session, bond markets began the day in slightly stronger territory.  The shorter end of the yield curve began the day in much stronger territory, carrying on the theme discussed in the Day Ahead charts.  As the morning progressed, longer-dated bonds were clearly sold for two reasons.  The first--and probably biggest--motivation was the age-old, super simple asset allocation trade.  In other words, bonds were sold so stocks could be bought at the open. 

Secondarily, month-end tradeflows look like they're attempting to keep the spread between certain parts of the yield curve at certain levels.  For example, the spread between 10 and 3yr Treasuries topped out at 1.053% yesterday, and that level has served as a central point of gravity today.  When things have flattened too much, 10's are sold and 3's are bought.  Conversely, the morning weakness made things steep enough (10's higher vs 3's) that the trading went the other way heading into the 11am hour.

The economic data served as a tailwind for that flattening.  Weaker data tends to promote a flatter curve.  The data was indeed weak, with Chicago PMI coming in at 46.3 vs 51.5.  Consumer Confidence was better than expected at the headline level, but there were several weaker internals.  Beyond that, it was clearly Chicago PMI that motivated the lion's share of the trading response.  By the time Consumer Confidence rolled around at 10am, the curve was already back to those central levels and it hasn't made any new lows or highs since then. 

The rally in 10's and MBS is still being led by the shorter end of the yield curve.  If we go back (way back) to my analogy of MBS being like a dog on a leash, this yield curve stuff is just another example of that same phenomenon.  This time, it's the short end (2's, 3's) that are the master, and 10yr yields are the dog, lagging behind, but only as much as the leash will stretch.  So as long as 3's are moving into stronger territory, the longer end of the curve (which mostly includes production MBS like Fannie 3.0s) will continue moving in the same direction, even if at a reluctant pace.