This is due to the fact that rebase first updates to 'target' and then
merges it with the branch that's to be rebased.

i.e., Given repo1 and repo2
Repo1:
 a - b

Repo2:
 a - c

hg pull --rebase in Repo2 means:
1 - pull b and we obtain:
 a - b
  \
   c

2 - rebase c onto b, that is "update to b and merge with c". Hence, b
becomes the 'local' revision.