We knew that bonds would be forced to accept more volatility in October, if for no other reason than September’s progressive and ultimately complete absence of volatility. The new month has not disappointed in that regard, although the trading levels are a bit of a disappointment for those who’d prefer rates to always be at all-time lows. Fortunately for them, there’s been a massive amount of MBS outperformance. Coupled with lender margins that are still extremely wide, mortgage rates haven’t had to experience anywhere near the level of weakness seen in Treasuries over the past 4 weeks.
With one week left to trade in October, should we expect to see the prevailing trend continue? That depends on the news that hits, as well as the extent to which traders have positioned for a tough week.
Such positioning is definitely a part of the aggressive selling pressure since the middle of the month. Notably, stocks have not been as highly correlated as we might expect, given the “stimulus headline” narrative. In other words, if markets were only reacting to stimulus headlines, the blue and yellow lines should be spending more time moving in the same direction recently. The fact that they’re not adds credence to the “positioning” narrative for the bond market.
So what’s this positioning narrative all about? First and foremost, traders know we have some sort of stimulus news coming. As of last week, there was increasing chatter in Washington about a deal getting done before the election. When that chatter was downplayed on Friday, bonds dialed back the selling spree, but there’s no reality without some sort of deal, likely within the next few weeks.
Beyond stimulus, bonds may have seen a perfect opportunity to try to push prices into cheaper (i.e. higher yield) territory ahead of confluence of events in the week ahead. These include the Treasury auction cycle (which can always lead to some preemptive cheapening in bonds, month-end bond buying needs, and a few key economic reports that could break the recent mold and actually have a bit of a bond market impact (namely the first reading of Q3 GDP, with Durable Goods, Inflation data, and Chicago PMI playing supporting roles). Add the uncertainty surrounding political matters (stimulus, election…) and one might even think of this confluence as a perfect little storm for bond market negativity. Then again, one might also think of it as a simple continuation of a pattern of ebbs and flows seen throughout the post-pandemic time frame.
One last chart to keep in mind, and an argument in favor of bonds slowing their roll with respect to additional selling pressure is the national covid case count. This isn’t the result of a few key states whose numbers are blowing up. In fact, as of last week 26 states recently posted record numbers or close to them.
Investors keep saying that rates will be low and sideways as long as covid numbers look like this, but that assumes the numbers line up with a certain amount of negative economic impact. With that in mind, it’s safe to say economic contraction as a function of covid case counts is a lot lower (economy doing much better) than it was earlier on in the pandemic.