Treasuries Bounce Off an Important Level for Financial Markets - Brian Reynolds
[This is interesting - He is claiming that it is the mortgage industry itself that does not want to see another round of refinancings]
Increased issuance now comes into the mix
On Friday, we wrote that Treasury yields had gotten down to an important support level for financial markets, below which we would likely see a surge in mortgage refinancings. During the day yields moved just below that level and then rocketed up, which brings up another interesting dynamic, as we are just about to enter the time of year when Treasury auctions are at their seasonally highest levels of the year.
Recap:
We came oh so close on Friday to the point where yields would have prompted the surge in refis before the Treasury market sold off. Some media reports credited a wire story that some ECB members might be amenable to easing policy in coming months as reason for the selloff but, from our vantage point, we don't view that as a major reason for the selloff. First, it is old news that foreign central banks will be more likely to ease if they become overly worried about the strength of their currencies. Second, while this news may take away some of the foreign bid in Treasuries, it would likely increase the domestic bid, as the carry trade's benefits would likely continue for a longer time, making this news a wash.
Instead, from the view we had of Friday's trading activity, the nervousness among the mortgage investment community was almost palpable as the yield on the 10-year Treasury fell to and then slightly below the 3.93%. Mortgage investors know they will likely have to buy Treasuries in size should yields fall significantly below that level in order to hedge themselves against higher prepayments.
As the yield broke below 3.93%, the excitement of bond bulls was tangible, and the price and volume began to accelerate. At that point, when the bulls had been sucked in, it seemed that the entire mortgage community ganged up on them to knock Treasury prices down.
This action pushed Treasury yields up to the 4.07% area, but the push by mortgage investors to get yields up was so strong that we saw a pickup in Treasury volatility. Granted, it came from extremely low levels, and is thus not yet cause for panic, but if volatility were to continue to pick up, that would be almost as bad for the mortgage community as a fall in rates because of the optionality of mortgages. A rise in volatility has the potential to worsen the environment for corporate bonds and thus stocks, so we will need to monitor this.
Treasuries at an interesting point:
So we are at an interesting point for Treasuries. From a purely technical standpoint, having bounced off support, yields should work higher. From a fundamental standpoint, we are approaching next Friday's payroll employment report. That report brings the annual benchmark revision, where the BLS goes back and revises years of history based on a more detailed analysis of the data.
Just about every economist is looking for an upward revision to recent numbers, as often happens when the economy accelerates. This would put the payroll data more in line with the unemployment claims numbers and the household employment survey. If there is not a substantial upward revision, then there is the potential for Treasury yields to drop below the threshold that would lead to mortgage refinancings and mechanical mortgage buying to hedge that.
From a supply and demand standpoint, we've noted in the past how the period from the end of January to the beginning of April is the time of year when the Treasury's borrowing needs are the greatest, due primarily to the fact that taxpayers who are due refunds tend to file early, while those who owe money tend to file in the 10 days before April 15. As last year's tax bill will lead to a number of people who are owed refunds, this tax season should see a record amount of borrowing. So, if Treasury yields are going to ever break to new highs and escape the power of the carry trade, the supply situation of the next two months would seem to provide the best opportunity in a while. |
