Bonds Erase Most of The AM Losses

The bond market was visibly pulled in two directions on Tuesday. This played out in phases, with AM weakness followed by a gradual recovery. But it can also be assumed to be playing out at any given moment as bonds listen to the voices arguing in their own mind. One voice says yields need to go higher due to inflation expectations and Treasury issuance implications.  The other says that Treasuries are still a global safe haven amid geopolitical uncertainty (and, to a lesser extent, that the sell-off through 9am this morning may have been a tad overdone).  Looking at stocks vs bonds, it does indeed look like yesterday was more about inflation fears and new-month positioning while today was a risk-off move that started at the 9:30am NYSE open. 

Market Movement Recap

08:48 AM Another overnight session with heavy selling. 10yr up 6.4bps at 4.099 and MBS down 9 ticks (.28).

10:58 AM decent recovery in 10am hour. MBS down less than a quarter point now and 10yr up only 3.3bps at 4.069

01:39 PM Recovery continues. MBS down only an eighth and 10yr up 1.6bps at 4.052

04:13 PM Off best levels heading into the close. MBS down 5 ticks (.16) and 10yr up 2.6bps at 4.062

Bonds sold off again overnight with 10yr yields now challenging the 4.10% technical level in early trading. MBS are down another 3/8ths, roughly. And there’s stronger correlation with higher oil prices and rising bond yields. So in light of our contrarian take yesterday, are we now forced to acquiesce to the “higher inflation/higher rates” narrative?  Not entirely. While there’s no doubt that a certain contingent of smaller traders are drawing that conclusion, and while there’s better evidence for it in some of today’s charts, there remains a problematic reality in an even simpler chart. There’s a tradeable security that measures market-based inflation expectations and it has shown almost no uptick in the past 2 days.

Smart analysts are calling out this oddity. Unfortunately, it doesn’t do anything to help us explain the scope of the sell-off, but we strongly suspect Treasury issuance implications are a factor as they relate to military spending.  Lastly, if we look at shorter-term TIPS, we can see slightly more inflation concern, but not enough to say “this is the main reason bonds are selling.” That has us thinking about things like issuance implications from increased military spending.

Here are the charts showing how yesterday’s correlations have reversed course today for stocks/bonds and oil/bonds. 

Last but not least, this chart shows today’s much more noticeable uptick in the implied Fed Funds Rate for the June meeting. In other words, rate cut odds evaporated more quickly today (although they have bounced back a bit since 6:30am ET).

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Big Bad Day For Bonds. What’s Next?

Bonds sold off early and aggressively on Monday in a move that most onlookers are quickly attributing to geopolitics. Specifically, the thought is that higher oil prices imply higher inflation and, thus, higher rates. While some traders probably woke up and decided to sell bonds based on this logic, they didn’t account for the pace of the sell-off. Rather, it was a perfect storm of timing and technicals with Friday’s month-end positioning leaving bonds overbought and well through the 4% technical floor. Today ran the risk of being a selling day anyway, but the obvious goal of re-entering the 4%+ range made it that much more swift. Closing out at 4.04% doesn’t seem too bad in the bigger picture. It’s a hard reset in the short term, but not necessarily a sign of additional momentum. For that, this week’s econ data would need to gang up and send a bullish message for the economy.

Econ Data / Events

ISM Manufacturing Employment (Feb)

48.8 vs — f’cast, 48.1 prev

ISM Manufacturing PMI (Feb)

52.4 vs 51.8 f’cast, 52.6 prev

ISM Mfg Prices Paid (Feb)

70.5 vs 59.5 f’cast, 59.0 prev

Market Movement Recap

09:08 AM Mostly flat overnight with sharper selling starting at 7am. 10yr up 5.9bps at 4.009 and MBS down just over a quarter point.

10:04 AM a bit more weakness after ISM data. MBS down 10 ticks (.31) and 10yr up 8.8bps at 4.036

11:40 AM New lows with MBS down 3/8ths and 10yr up 10.3bps at 4.051

03:30 PM MBS still down 3/8ths and 10yr up 9.9bps at 4.046

Mortgage rates began the new week with a fairly quick jump back into the low 6% range (top tier 30yr fixed rate for the average lender). With the news cycle very focused on developments in Iran, most coverage attempts to correlate geopolitical events with market movement. The only legitimate way to do this would be to say that upward pressure on oil prices is translating to higher inflation implications and therefore higher rates. At many times in the past, this would be a solid conclusion. To some small extent, a case could even be made for this correlation accounting for a portion of today’s weakness. But most of the big, directional moves in oil prices over the past 2 days have failed to correlated with big moves in the bond market.  Even when we zoom out to wider frames of reference, we see counterintuitive developments over the past several years. When oil peaked around $120/bbl in 2022, 10yr Treasury yields were around 3%. When oil fell sharply into 2023, bond yields continued moving up and have held flat for the last few years even as oil gently declined. Nonetheless, there are also pockets of correlation where we can see the two lines moving in the same direction. The only problem with that is that oil and rates can both respond to a third variable: economic strength. On that note, this week’s economic data may be just as big of an influence on rate momentum while geopolitical developments represent a wild card that can create a backdrop of volatility.

Spoiler alert: it’s not Iran. And this morning’s yields are the 2nd lowest in more than 3 months behind last Friday. Last Friday was also a month-end trading day with a mini snowball rally that defied overt explanation (apart from “month end bond buying”)–a fact that led us to warn about the risk of “new month bond selling.”  It’s not that bonds always rally at month-end or sell off when the new month begins, but if there’s a sharp, inexplicable move on the last day of any given month, the risks of a reversal increase on the first day of the following month. Geopolitical headlines may cause modest volatility here and there, but bonds’ correlation with oil prices is not a reliable analytical focus.

The next chart shows what oil and bond yields had been doing on the last 3 days of last week.  Notice the extreme absence of correlation.

Here’s the move so far today–the one that has people concluding that bond yields are higher because oil is higher.  In fact, versus the 3pm CME close on Friday, bonds were flat until 7am.  By that time, oil had already experienced almost all its volatility for the day.  The crux of the bond sell-off played out in a vacuum–STRONGLY suggesting Friday’s yields were dragged down by month-end buying and this morning’s selling is “new month” positioning.