Many believe that if you talk long enough about a recession, eventually we’ll see one. Chris Bennett, Principal at Vice Capital Markets, Inc. sent out a note to clients back last Friday the 13th on proverbial blood in the streets in the town of Chicago. (“There’s blood in the streets, it’s up to my ankles…………. Blood in the streets it’s up to my knee” “Peace Frog”, by The Doors.) “I know some folks that follow mortgage rates on news services were feeling like their prices seemed to move more than their services said MBS were changing (I got a couple of messages on it earlier last week), but they may have been looking at 3.5s or 4.0s or a more premium coupon – prices for current-coupon MBS have gotten slapped down hard the previous 7 trading days – Fannie (UMBS) 3.0 dropping 160 basis points and 2.5s tanking a whopping 2.30 points. With the spreads between coupons as tight as they are, that can be .500% or even more in zero-point note rate, again in the span if just over a week. It’s been double a typical month’s worth of total market movement in just 7 trading sessions, a swift move indeed.
“I’m sure people are freaking out a bit and wondering, ‘what the heck happened, just why did treasuries and mortgages get smacked so hard so fast?’ There are a number of news stories one can pick from, but the real reason is a simple and plain one, that has been going on ever since the dawn of trading exchanges: Most of what you see in the markets on any given day is nothing more than flight or fight between buyers and sellers.
“I’ve been a trader for 32 years now, in everything from corn to yen to gold to coffee to our good old-fashioned stocks and bonds, and this statement is true in every single market there is. Do fundamentals matter in the long run? Absolutely! But on any given day what the market for oats or platinum or Mortgage Backed Securities do is just the simple daily fights between bulls and bears trying to squeeze the gonads of the other side to get them to abandon their positions. Economic numbers do matter, but when the market reaction doesn’t fit or there’s not a good explanation for a move people need to make up a reason to report on CNBC or Bloomberg or whatever as part of their job of making sense of things to their viewers.
“Is there anything that truly fundamentally changed in the last week and a half that sent the 10yr yield from 1.43 all the way up to 1.90? Nope, not really. Just like there was nothing that truly fundamentally changed during the month of August that sent that same benchmark 10-yr note yield from 2.02 down to 1.44 last month, most of it in the first 11 trading sessions. Last month buyers were squeezing the hell of out of sellers, and starting last week those buyers took their profits and the sellers squeezed the remaining guys right back. People need to remember where we came from – less than a year ago the 10yr yield was yielding 3.24, and the market had 3 more FOMC hikes baked in. Moving from 3.24 to 1.43 and a shift from expecting 3 tightenings to expecting 3 easings (one of which we already got, the second of which is coming later this month) in less than a year is a HUGE move, and like anything else, nothing just goes straight up or straight down. Countertrend moves like the one we just got are a very normal part of all markets, financial or otherwise.
“Where do we go from here? Well, it all depends on whether this current and expected Fed action is just a fine-tuning like they say it is, or the stock market starts to give way and this is the start of a broader easing cycle back toward the zero-bound. Right now the market believes the Fed’s “fine-tuning” language. And if stocks stay where they are that’ll be the right call. This economic expansion by historical terms is long in the tooth. Not really a whole lot to do with tariffs or politics as much as many might think, but just the natural cycle of human (both consumer and corporate) behavior. If the Europeans and Japanese come to the realization that lending money at negative interest rates is an Alice in Wonderland mushroom-tea induced paradigm and their bond markets start to fall apart some of that contagion will spread to our markets, but for now they’re all happily enjoying their place in Wonderland and helping to keep an anchor on our own yields. As of this moment the market (looking at Dec 2020 Eurodollar futures contracts) expects a de-facto Fed Funds rate (90-day LIBOR actually technically) of 1.65%. Our 10yr yield is at 1.90%. If those future FOMC expectations stay anchored there’s no reason we can’t stay in this broader rate range (call it 1.43-1.93 basis the 10yr treasury yield) for the balance of the year.” Thank you, Chris!