In the day just past, bonds extended the gains seen on Monday with 10yr yields hitting 1.98% before encountering resistance.  The gains are most readily attributed to an imbalance of short positions (traders betting on rates moving higher) and a smattering of strong buying demand amid low volumes.  The net effect was a short squeeze on Monday with a bit of follow-through on Tuesday morning ahead of a Powell speech.  Powell ended up being a bit more hawkish than expected.  Along with a speech from Bullard, this helped reinforce a floor under yields.

In the day ahead, bonds will continue to navigate a consolidation pattern that appears to be intact heading into the important events ahead.  The opening act for those important events would be this week's month-end trading process along with any potential trade headlines coming out of the G20 summit at the end of the week.  But traders are primarily interested in seeing how next week's economic data goes.  The consolidation pattern is currently set to collide/conclude/cross precisely by the afternoon of jobs report day.

The chart above leaves more room for Treasury yields to move higher inside this consolidation pattern, even if they continue to make "lower highs" relative to last week's levels.  Treasury weakness provides an ideal opportunity for MBS to catch up. 

Mortgages have definitely been lagging the recent bond market gains.  It's hard to illustrate this in a chart due to Treasuries trading in yield and MBS trading in price.  Granted, MBS yields can indeed be calculated, but the actual yield is a bit of a moving target due to uncertainty surrounding borrowers' prepayment behavior.  Moreover, MBS yields from an investor's standpoint are not as relevant as MBS prices from an originator's standpoint. 

As such, I like to chart 10yr yields versus INVERTED MBS prices (i.e. the higher prices are lower on the chart).  This lets us line up 10yr yields and MBS movement in a way that makes it easier to identify periods of varying performance.

One thing the chart doesn't account for is the fact that different MBS coupons come into fashion at different price levels.  Up at 10yr yields of 2.7% and higher, Fannie 3.0 coupons were much less relevant (practically non-existent).  Conversely, if 10yr yields stay below 2.0%, Fannie 2.5 coupons will become more and more relevant.  For instance, if 10s move to 1.85%, we'd see the blue line above continue to lag, but a line charting Fannie 2.5 coupons would do a better job keeping pace as 2.5 coupons would be in much higher demand, relative to 3.0 coupons, as the market moves toward lower rates overall. 

If you want one simple way to think about all this, here you go: in a falling rate environment, higher MBS coupons are at a greater risk of being paid off early (due to refinancing and, to a lesser extent, any additional motivation to sell).  Investors don't want to pay a premium (anything over 100-00) for bond that has a chance of being retired earlier than expected.  2.5 coupons would offer more "prepay protection" in a falling rate environment.