Thursday, 29 October, 2020

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MBS Week Ahead: Who Knows Where We’d Be Without Stock Market Weakness


One of my favorite pastimes is debunking the notion that stock prices and bonds yields ‘always’ correlate.  Years of indoctrination from the conventional wisdom of money managers have done us no favors as market watchers.  Even if you don’t invest or actively make decisions about your 401k allocation, you’re still likely familiar with the notion of moving out of stocks/bonds and into the other. 

The net effect of such asset allocation strategy is simple.  If you’re selling stocks to buy bonds, then charted lines of stock prices and bond yields would move lower together (because buying bonds = higher prices and lower yields).  This line of thinking makes the following stock/bond movement in early September very logical.

20200921 open3.png

Indeed, looking at the chart above, it’s easy to conclude that the conventional wisdom is right and that what I’m about to tell you is wrong.  But let’s zoom that chart out a bit.

20200921 open4.png

Striking, no?  As usual, the truth is somewhere in the middle.  We do indeed see strong correlation at times–usually over short time horizons (but even over longer time horizons in 1999-2009).  But the more we zoom out, the more that correlation breaks down.  The modified approach is to lean on the short term correlation when it’s clearly setting the tone.  Additionally, we also have to consider that the correlation won’t necessarily look perfect, even if one side of the market is definitely influencing the other.

While it’s harder to see with the naked eye, one of the best examples we have of this modified analytical approach is that of a burgeoning stock sell off making a case for bonds to abandon a gradually weaker trend.  The second half of last week is the most recent example.

20200921 open2.png

If we zoom out to a wider frame of reference, the correlation is harder to see, but the scope of weakness in stocks becomes more clear.  This is now the biggest sell-off for stocks since the post-covid recovery began.  Bonds certainly aren’t eager to follow suit, but they are nonetheless forced to absorb at least some of the dollars fleeing the stock market.  

20200921.png

If this is enough to prevent yields from breaking their current ceilings (0.73 and .79, most immediately), so be it.  That said, it would probably take a fairly massive stock sell-off to help bond yields get through their bigger picture floors at .63, .57, and 0.50.  On the other side of the coin, we also have to wonder how much of a recovery in stocks would be needed in order for bonds to get back to their previous business of pushing toward higher yields.  With a fairly light economic calendar, that’s actually one of our first orders of business this week: watching for a bond weakness in the event of stock market stability. 


MBS Pricing Snapshot

Pricing shown below is delayed, please note the timestamp at the bottom. Real time pricing is available via MBS Live.

MBS

UMBS 2.0

102-31 : +0-04

Treasuries

10 YR

0.6544 : -0.0396

Pricing as of 9/21/20 10:04AMEST

Tomorrow’s Economic Calendar

Time Event Period Forecast Prior
Tuesday, Sep 22
10:00 Existing home sales (ml)* Aug 6.00 5.86
10:00 Exist. home sales % chg (%)* Aug 2.4 24.7
Wednesday, Sep 23
7:00 MBA Purchase Index w/e 316.2
7:00 Mortgage Refinance Index w/e 3289.4
9:00 Monthly Home Price yy (%) Jul 5.7
9:45 PMI-Composite (source:Markit) * Sep 54.6
13:00 5-Yr Note Auction (bl)* 53
Thursday, Sep 24
8:30 Continued jobless claims (ml) w/e 12.339 12.628
8:30 Jobless Claims (k) w/e 843 860
10:00 New home sales-units mm (ml)* Aug 0.890 0.901
10:00 New home sales chg mm (%)* Aug -1.0 13.9
13:00 7-Yr Note Auction (bl)* 50
Friday, Sep 25
8:30 Nondefense ex-air (%)* Aug 0.5 1.9
8:30 Durable goods (%)* Aug 1.5 11.4