Market Commentary

Market Commentary…06/25/2009

Mortgage backed securities (MBS) prices are higher (rates lower) after yesterday’s volatile trading over the FOMC policy statement and before today’s Treasury auction of $27 billion in 7yr notes that completes the record $104 billion in borrowing; FNMA 5.0% coupon 101.58bps, +28bps and the high of the session.

The Fed, encouraged by signs the recession is easing, doused speculation they will pump more money into the economy. Fed policy makers will maintain the size and pace of their program to buy Treasuries, agency debt and MBS.

The statement indicated more time is needed to assess the prospects for a recovery before deciding to exit from their unprecedented credit programs and reinforced expectations that interest rates will remain low for some time.

Also emphasized was continued monetary stimulus is needed but the risk of inflation is low, easing concern that higher prices will erode the value of the fixed payments from debt.

The difference between 10yr note yields and Treasury Inflation Protected Securities (TIPS), which reflect the outlook among traders for consumer prices, narrowed to 183bps from 202bps two weeks ago.

The final revision to 1st quarter Gross Domestic Product (GDP), the sum of all goods and services produced, came in at -5.5% reflecting declines in inventories, housing and business spending and capping the worst six month performance in almost sixty years.

Residential construction dropped 39%, the most since 1980. Business investment shrank 37%, the biggest decline since 1947. Inventories fell $87 billion, the biggest drop ever.

On a positive note, the trade deficit narrowed contributing 2.4% to growth, while core PCE rose only 1.6%. Personal Consumption Expenditure is the Fed’s preferred measure of inflation.

Jobless claims unexpectedly rose for a second straight week, 15K to 627K from a revised 4K higher 612K indicating the labor market may take longer to stabilize. The data included unexpected claims from the educational services sector which often shows variability at the end of the school year. The 4 week moving average also increased to 617,250 from 616,750. The total number of people collecting unemployment insurance jumped 29K to 6.74 million.

Fed Chairman Bernanke is testifying today before the House Committee on Oversight and Government Reform regarding his role in Bank of America’s purchase of Merrill Lynch.

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Market Commentary

Market Commentary…05/27/2009

Lots of alerts from TBWS today, here’s why: The bubble in the mortgage markets finally and with super hyper speed, blew up today.

After holding and holding, while the 10 yr note rate climbed, mortgage rates jumped today to levels not seen in many months. We have been warning the mortgage markets couldn’t hold on forever while treasury rates increased.

Mortgage lenders became way too complacent with hedging risk, believing apparently that the $1.25T the Fed committed to buy would keep mortgage rates from increasing. Today, from almost the beginning mortgage markets looked very unstable; we sent several alerts suggesting deteriorating rates.

Frankly, we were not looking for the kind of pounding we got this afternoon.

Yields on Fannie Mae and Freddie Mac mortgage bonds rose for a fourth day, after yesterday for the first time exceeding where they stood before the Federal Reserve announced it would expand purchases to drive down loan rates.

It is finally hitting home that the Fed has a serious problem; the problem is how to keep mortgage rates down, the housing markets are the key to any economic recovery and one of the keys to getting the housing sector back on track is keeping mortgage rates affordable and low.

It was widely thought that buying $1.25T of MBSs would do it.

Not the case; we all know about the massive supply Treasury has to sell in the debt markets, as we have noted it is unlikely that can happen (raising $200B a month along the yield curve, not including T-bills under 1 yr) without higher rates and the potential of creating inflation fears.

Today may be a Waterloo for the Fed; what to do?

Buy more treasuries, buy more mortgages? Markets are not going to be placated by either move; the Fed can’t keep it up and as the US debt increases foreign central banks, led by China, may make good on recent comments to stop buying US debt.

Who then will fund our deficits and the Obama Administration’s aggressive fiscal budgets?

The US is completely dependent on foreign investments to fund our debt and that point is beginning to take front page.

Big hit in the equity markets this afternoon on the hard hits taken in the mortgage markets. Without lower mortgage rates the economy isn’t going to recover at the pace recent thoughts had developed. If housing and home prices are not stabilized there isn’t going to be much of a recovery based on the timeframe markets had been expecting.

The $35B 5-yrs went at 2.310% with a 2.32 bid-to-cover and indirect take of 44.2%, the outing was solid. The results were against an average 2.13 cover over the past 16 auction since the start of 2008, and a 29.2% indirect bidder take. The market had been looking for a solid showing, and while this was less impressive than the 2-yrs, that was also expected.

The market had been looking for a draw of 2.33% plus and liked the lower yield. More Treasury borrowing tomorrow; $26B of 7 yr notes will complete this week’s $101B of borrowing.

Markets will have two weeks to breathe before Treasury comes back with 3 yr, 10 yr and 30 yr bond auctions on June 9, 10, and 11.

Tomorrow weekly jobless claims at 8:30 expected to be up 5K; and April durable goods orders (+0.5%). At 10:00 Apr new home sales are expected to be up 1.8%.

The selling today adds to the technically oversold markets. Mortgage rates cannot stand against the increase in long term treasury rates. The spread between the 10 yr note and 30 yr mortgages came back in line two weeks ago as we reported, back to about 165 basis point from a high of 270 basis point six months ago.

Keep all rate locks locked and strap in for a significant increase in market volatility with mortgage prices swinging with treasuries in large daily increments.

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