MBS Week Ahead: Bonds Attempting to Confirm a Breakout by Mathew Graham Jan 27 2020, 9:45AM
Last week was really the first truly interesting week of 2020 (and arguably of the past several months) as far as the prevailing range in the bond market is concerned. Yields had been narrowing since September and were holding a very tight range since mid-October. By Friday, 2 of the 3 potential boundaries (there are different ways to approach them) were broken by a rally in the bond market.
But “broken” is a bit of a subjective term when it comes to following “key levels” or other lines (like moving averages or trend-lines) that a technical analyst might use to interpret bond market momentum. Traditionally, the first move past such a line is referred to as a “test.” In other words, bonds are testing their ability to operate on the other side of a line that had previously turned them away. If they’re able to do so, the 2nd part of a breakout is referred to as “confirmation.”
Friday, then, provided a compelling “test” of 2 of the 3 lines we’ve been watching. One of those lines is a simple horizontal pivot point at 1.69-1.71% (personal preference can dictate exactly where to place that). The other broken line is less subjective as it perfectly connects the last 3 major lows (the teal line below). The only other resistance line (aka “floor”) was the longer-term trend-line connecting all the lows from the 2nd half of 2019 (yellow line below).
Long story short: if today’s gains hold, 2 of the 3 floors will be confirmed broken and the final floor will be aggressively “tested.” If that test is confirmed tomorrow, the implication is for the rally to extend down to the previous lows in the 1.4-1.5% range.
Of course if bonds are on the move to such an extent, we have to ask why. In this case, we know a good amount of the movement is due to coronavirus concerns. That’s unfortunately not very solid footing for a sustainable rally so we shouldn’t get too attached to it unless it’s joined by weaker economic data. We’ll get plenty of opportunities to assess data this week as the calendar is night-and-day busier versus last week. In addition, there’s another round of Treasury auction supply to assess bond traders’ level of demand.
Last but not least, the Fed releases a new policy announcement on Wednesday. While it’s hard to imagine what the Fed could say to surprise the market (i.e. they’ve been clear they’re neither hiking nor cutting without a major shift in inflation or jobs), that hasn’t stopped bonds from having at least a moderate reaction in the past. If all of the above happens to align in a bond-friendly way (weak data, strong auctions, no surprises from Fed), this rally could keep going even without a major deterioration in the the coronavirus containment outlook.