Another week, another chance to see if bonds will continue to avoid confrontation with the boundaries of the recent range. 1.075% emerged as the floor to beat in terms of 10yr Treasury yields over the past 2 weeks, with multiple unsuccessful breakout attempts. In the first hour of trading in the new week, yields were already giving it another try–this time with a bit more conviction, but not enough follow-through to close the case.
Despite the breakout attempt, gains stalled out shortly thereafter. This reinforces the notion that progress will be hard-fought without obvious, compelling motivations. On that front, there are several candidates in the near term.
We know that the political landscape has generally had a negative impact on bonds recently, with the US government expected to issue more Treasury debt to pay for stimulus upgrades. As such, anything that gets in the way of those stimulus upgrades could motivate some friendly momentum. With that in mind, doubts are emerging as to how quickly congress will be able to agree on Biden’s 1.9 trillion dollar spending package with impeachment proceedings potentially monopolizing congressional time and energy.
Beyond politics, the core consideration of “covid vs the economy” is still a thing. Jobs haven’t remotely recovered pre-covid levels, nor will they even come close to doing so in 2021 based on the current pace of improvement. But wait! There are vaccines! So once we realize the dream of broad-based immunity, jobs will come flooding back, right?
That’s a big unknown in two major ways. On a more objective, superficial note, the vaccine roll-out has been imperfect enough to raise concerns about how quickly broad-based immunity can be achieved. At the same time, the emergence of new covid strains raises questions about the level of protection vaccines will offer. Even if you want to be more optimistic about it, the new strains and slow vaccine roll-out cause a delay in the economic recovery that’s supposedly responsible for our current rising rate environment.
Finally, there’s that recovery itself. It’s been surprisingly good in many ways, so far. Some economists worry that the light at the end of the tunnel may grow dimmer as the year progresses. Job destruction that was hopefully temporary in nature could increasingly be seen as permanent and the econ data could begin to reflect that reality. If it does, that’s a scenario that allows bond yields/rates to remain in the historically low post-covid range.
In terms of this week’s data, there are a few key reports that will continue fleshing out the economic picture. We’ll get our first look at Q4 GDP on Thursday morning (currently expected to come in +4.0% which would help 2020 close out on a positive note). Other headliners include Durable Goods on Wednesday morning and the Fed announcement later that same afternoon (the Fed isn’t expected to drop any bombs, but traders are constantly on the lookout for clues).
In the specific world of mortgage rates and MBS, we continue tracking the restoration of normal lender margins/spreads. In other words, average rates have been historically high compared to MBS yield–partly a function of lenders being at max capacity and needing to keep rates higher to throttle inbound lock volume, and partly a function of increased servicing costs associated with covid-related challenges for mortgage borrowers. Our baseline has been that the normal spread between mortgage rates and MBS is likely roughly 20bps higher than the “old normal.”
As of last week, we saw yet another bounce at exactly those levels. While we expect this line to be broken at some point, the longer it remains unbroken, the more the mortgage market is confirming that it has reconnected with the bond market (thus, mortgage rates would be less capable of defying broader bond market momentum if that momentum suggests it’s time for rates to move higher).