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MBS Day Ahead: Rising Rate Risks Are Officially Getting Serious

November 6, 2019
by admin

Yesterday brought a brief reprieve for bonds after the first 2 days of the week threatened to confirm a big picture shift toward higher rates (or at least to build a case for such things). But much like the brief rally in the middle of last week, yesterday’s rally proved to be a head fake, only this time, it was even less convincing. In fact, it took place entirely within the confines of the weeks-long uptrend in rates (white lines in the chart).

Now today, bonds started out in significantly weaker territory after overnight trade headlines rocked both sides of the market (good for stocks, bad for bonds). MBS Live subscribers can get caught up with that move HERE. The losses are already pushing the upper limit of the shorter-term trend.

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1.90-1.94 is an important line in the sand for yields. It separates the summertime surge from the rest of the long-term rally with a very clear high in mid-September and a very clear low in early July. These sorts of inflection points CAN be targeted as ceilings that motivate bond buyers to get more aggressive, but they can also be lines in the sand that signify a shift into a longer term uptrend in rates.

I’ve been concerned about the latter ever since August’s big rally. By then, yields had fallen far enough and for long enough to put 2019 on par with many other long-term bond rallies. To make that list, a rally needs to have covered at least 100bps. The chart below gives examples of the market movement that has followed those rallies.

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The 2 best case scenarios are seen in 2011 and 2015. Of the two, 2011 bears more similarity to 2019. That is worth some small consolation as we’ve already almost matched the initial rebound in late 2011. If the pattern were to perfectly repeat itself (it won’t, but just for the sake of argument), yields would soon drop back to recent lows and then rise back up to 1.90%-ish by March 2020. In more dire scenarios, we’re looking at another several months of weakness, and notably, in the 2009/10 example, that could be followed by another 8-12 months of volatile, sideways momentum before the next true rally emerges. I’m not sayin this WILL happen, but it is something you need to be prepared for. We don’t know how long the weakness will last or how far it will go, but all other things being equal, the size and scope of 2019’s rally make weakness more likely than strength for the rest of the year.

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