Mortgage Blog

Yesterday, Bond prices edged lower after the Fed left the Fed Funds Rate unchanged at 5.25%, while confirming in its Policy Statement that inflation remains its leading monetary concern. In the Fed’s brief statement, there was little to no commentary on the “credit crunch” situation facing the mortgage industry. Although the Fed didn’t have much to say on the situation, many others are speaking out about it – including Senator Chuck Schumer, who is calling for a temporary lift of the FNMA and FHLMC limits, so that they can accommodate a larger number of loans.

Additionally, there is some saber-rattling going on, which could eventually become a game of “chicken” between the US and China. In response to the US threatening trade sanctions against China, China is threatening to dump a large amount of their $1.3 Trillion of US Bond holdings. The result would be higher rates, as an already fragile Mortgage Bond market would have to scramble to sop up the added paper in the marketplace. We feel that this scenario is an unlikely one, as the drop in price would hurt the amount received by China on selling its paper and dramatically reduce the value of their remaining holdings. And from a strategic perspective, it would be very unwise to telegraph such a move in advance.

Later today, the Treasury Department will be auctioning off $13 Billion of 10-yr notes. This added supply could pressure Bond prices lower, if it is not met with ample buying as well as strong foreign appetite.

Technically – there are some negative signals appearing, as Bonds now have a negative Stochastic crossover from an overbought state. Additionally, Stocks appear poised to make another move higher - therefore, risks now favor locking any loans.

The market volatility continues as Mortgage Bonds are trading higher after yesterday’s 34bp sell-off. Prices still remain below a very tough and now tested ceiling of resistance at the 200-day Moving Average.

This morning’s economic news had little initial market reaction. But there were some clues about the labor market from another increase in Initial Jobless Claims numbers. Initial Jobless Claims were reported at 334,000, above expectations of 320,000, and the highest level since April 14. As we have said, it was just a short time ago that this number was around the 300k level. Let's keep this in mind ahead of next Friday's Jobs Report.

The Preliminary Gross Domestic Product (GDP) for the second quarter was revised to 4.0%, which was slightly below expectations of 4.1%. The number is better than Q1, but still a bit on the slow side. The good news is that the growth is still positive and not recessionary.

Traders are very focused on tomorrow's action, which includes a speech from Fed Chair Ben Bernanke and the release off the Core Personal Consumption Expenditure (PCE) – the Fed’s favorite measure of consumer inflation.

Everyone wants to know…will Benny and the Feds soon pull the trigger on an interest rate cut? Or will they continue to tweak inter-bank interest rates at the Fed Discount Window with repurchase agreements and then sit back and see what unfolds in the financial markets? The stock market wants a cut in the Fed Funds Rate badly and will likely sell-off sharply if it does not materialize. Bonds will look to the Fed's posture on the decision. If the Fed says inflation is in check, bonds should be happy. But inflationary remarks will hurt bonds. We still think the Fed has the green light to cut...but we have two verys target zone of 1 to 2%. Should this number be reported at 0.1%, like it has each of the past several months, Bonds may receive a boost. We think PCE will remain within the Fed zone, bonds will like it, but hang under the 200-day MA

This morning, the Fed lowered their Discount Rate by .50%, taking it from 6.25% down to 5.75%. The Discount Rate is the rate at which the Fed lends money directly to commercial banks, credit unions and savings and loans including large lenders like Countrywide and Bank of America. It is different than the Fed Funds Rate, which is the rate at which banks lend money to other banks. The Discount rate is usually held 1% above the Fed Funds Rate, which makes the Fed a last resort for lending institutions to borrow from - they would generally of course rather borrow from other banks at a lower rate - but with the current liquidity crisis making that difficult, this move will help provide some liquidity at more desirable rates in the short term.

More importantly, the Fed is extending the borrowing period from overnight to 30 days, which could allow some lenders to use the discount window for loan fundings prior to sale in the secondary market. The 30 day extension allows time for the credit markets to settle a bit so that buyers of mortgage-backed securities can come back into the market. We have been telling you how important the next 30 days are, and this Fed move does help some large financial institutions better weather the storm. Additionally, and as we have been forecasting, it is highly likely that the Fed will cut the Fed Funds rate on or even before the next Fed Meeting on Sept 18th.

Mortgage Bonds appear to be yawning at some good news on consumer inflation by way of the Consumer Price Index.

The Labor Department reported the Consumer Price Index (CPI) for July at 0.1%, which matched expectations. And the more closely watched Core CPI, which factors out volatile energy and food prices, also met expectations at 0.2%. The lower overall CPI was attributed to lower gasoline prices during the month and was the lowest headline consumer inflation rate during the past eight months. With this latest read, the year over year headline CPI now stands at 2.4%, while the Core CPI is 2.2% year over year. The report shows that core inflation is stable to moderating and this is good news for Bonds and the economy longer-term.

Yesterday, Bonds were able to make a successful bounce higher off of the 25-day Moving Average. With the next level of resistance about 40 to 50bp higher than present levels, we want to be patient and see if prices can add to those gains. But Bonds may again be at the mercy of Stocks...and at the moment, the Dow is attempting to stabilize above psychological support at the 13,000 level. Should Stocks improve further, it may be at the expense of Bonds as money flows from Bonds and into Stocks. For the moment, we advise cautiously floating, but be ready to take action if Bond prices turn lower.