Current Trend Direction: Sideways in a Wide Range

Risks favor: Carefully Floating

Current Price of FNMA 4.0% Bond: $99.84, +12bp

Mortgage Bonds are trading modestly higher and remain in a range between strong overhead resistance and support at the 25-Day Moving Average. Yesterday afternoon, Moody’s downgraded Greece’s debt to junk status…and while this did not come as a real surprise, the markets reacted to the news, with Stocks giving up their gains on the day, and Bonds erasing all their losses.

San Francisco Fed President Janet “Always” Yellen is suggesting that in her opinion, Fed rate hikes shouldn’t need to happen until 2012. This is in sharp contrast to the growing list of Fed members who are feeling that a rate hike towards 1% should be happening right now. So we have members of the very same Fed, hearing the same data, that are in wide disagreement with one another.
The New York Empire Manufacturing Index came in at 19.57, nearly in line with estimates of 20.00. The report had little effect on the markets.

Executives from BP, ExxonMobil, Chevron, ConocoPhillips and Royal Dutch Shell will be on Capitol Hill today, testifying in front of the House Energy and Commerce Committee on offshore oil drilling and the effects of the massive oil leak in the Gulf. This comes before President Obama’s speech tonight at 8:00pm ET on the catastrophe in the Gulf…which will be his first address from the Oval Office.

Since the expiration of the Homebuyer Tax Credit, some purchasers are feeling that they may have missed an opportunity. But the recent drop in rates to historic lows after the expiration of the Tax Credit, could offset most if not all of the expired benefit. Much depends on estimated time in the home and loan amount, but you may want to do a calculation for your potential buyers based on how much they are saving each month in rate today, compared to where rates were at the end of April. In fact – use your new MMG Benefit, the Borrow Smart Analysis software to check it out right now. If you haven’t downloaded it yet – just look under Member Benefits on the site for your free download.
For now, we can continue to Float – but watch carefully, as prices approach a tough ceiling of resistance.

Current Trend Direction: Sideways in a Wide Range
Risks favor: Carefully Floating
Current Price of FNMA 4.0% Bond: $99.53, -19bp
Mortgage Bonds are starting the week lower, as the credit woes out of Europe have eased a bit…at least for the moment. The Euro is attempting to stabilize from its recent decline and now hovers near $1.22 against the US Dollar, which means it takes $1.22 USD to buy 1 Euro. The Euro had dipped below $1.20 in recent weeks. This positive move in the Euro was sparked by some good economic reports out of Europe, which has also helped propel most of their Stock markets higher…and this is coming at the expense of Bonds. A look at the Bond Page shows that Bond prices were pushed back lower from overhead resistance last Wednesday, and currently remain beneath this tough ceiling.
There are no economic reports due for release today and there are no Treasury Note auctions this week, so today’s trading will likely be influenced by Stocks and any breaking news out of Europe, as well as the aforementioned technical signals.
St. Louis Fed President James “Raging” Bullard, a voting member in 2010, was in Japan this morning saying that the European crisis should not cause the Fed to postpone raising interest rates as the US economy recovers. He went on to say that “While the sovereign debt crisis in Europe is indeed a serious matter, the global recovery at this point looks very strong, and seems unlikely to be derailed.” As we discussed in Friday’s Update, Mr. Bullard is part of a group of Fed Members who have expressed concern about the present accommodative policy and the need to hike rates sooner rather than later.
We can start the day by Carefully Floating, while paying very close attention in this volatile environment.

Risks favor: Floating

Current Price of FNMA 4.5% Bond: $102.53, +47bp

The Jobs Report was a complete surprise, and a disappointment in general. It was far worse than most estimates, including ours, as we had felt that the risks were for a stronger Report. And as a result, Mortgage Bonds are trading higher – but we need to pay close attention, as prices are right near a strong resistance level.

The headline number in the Jobs Report showed 431,000 jobs created in May, quite a bit below the 500,000 that were expected. And of that 431,000, there were 411,000 temporary census workers hired…so this was not a good number. Private employment increased by just 41,000, quite a bit below Wall Street estimates and the weakest gain since January. There were no revisions to April’s reading, but March was revised to show 22,000 fewer jobs created, taking that number to 208,000 jobs created from the previously reported 230,000. And even the Household Survey – which had shown 1.1M jobs created over the past three months – showed a very poor number last month, of 35,000 jobs lost during May.

As we have often written to you about over the years, the Household Survey or Current Population Survey (CPS) may be a more accurate reading, because this is where actual households are contacted. Additionally, this is the survey that gives us the Unemployment Rate. The headline job creations number that you hear about in the media comes from the business or Establishment Report, also known as the Current Employment Statistics (CES). This report includes the “birth-death ratio”, which we have also written to you about and explained to you about for several years. It’s interesting to see how just lately, some of the media networks appear to have just caught on to how misleading the birth-death ratio can be.

Obviously the number was a disappointment, but there still were modest job creations. Additionally, average hours worked did improve, which is a good sign. And the Unemployment Rate did drop from 9.9% to 9.7%.

Even before the disappointing jobs news, the stage was set for lower Stock prices and higher Bond prices, with more troubling news out of Europe this morning. Hungary has stated that they are in a “very grave situation” as it relates to their economy. This constant negative turbulence out of Europe has pushed the Euro down towards $1.20 this morning. And once the jobs number came out, the Stock losses and Bond gains accelerated.

Next week the Treasury will auction off $70B in 3 and 10 Year Notes and 30-Year Bonds. It will be interesting to see how these auctions perform with yields at very low levels.

We will start the day by floating and watch how prices trade near resistance. Be mindful that the last couple of times the Bond was near these levels, it did retreat lower.

Risks favor: Floating

Current Price of FNMA 4.5% Bond: $102.53, +16bp

Bonds are higher again this morning, as Stocks started the day with another round of selling. The sharp sell-off in the Stock market has certainly helped Bond prices of late, as some of the money from Stock sales is finding its way into the Bond market, including Mortgage Bonds. And a closer look at the Stock sell-off shows that some important technical damage has been done. The important 50 and 200-day Moving Average floors of support have been broken on all the major indices. And earlier this morning, the low of May 6th – that wild day two weeks ago that regulators are still scratching their heads about – was broken on the S&P 500. But since then, Stock prices have improved back above those lows, and are trading near flat on the day.

Another point on the Stock market is that prices are now down more than 10% from their peak. This is significant because it is called a correction, if prices recover and resume their uptrend. A correction can be quite healthy, and help a Bull market sustain its strength. But here’s the trick – if the market drops 20% from its peak, it’s officially considered a Bear market. That means every Bear market was once potentially just a correction.

And that’s exactly where the Stock market sits right now – and so the debate rages on. Is this a time to buy, because you believe it’s a correction, and prices will move much higher? Or is this a time to sell, before the correction turns into a Bear market? The answer should become clearer over the next few days, as the markets decided direction takes hold. Waiting in the wings are Bond prices. A Bear market could help Bond prices improve a bit more, while a correction back to a Bull market will be at the expense of some of the recent gains that Bonds have enjoyed.

(A quick side note – why “Bulls” and “Bears”? It’s all in the way they attack. Bulls attack by an upward thrusting motion with their horns, and Bears attack by moving their powerful claws in a downward motion.)

The Senate passed the controversial Financial Regulation Bill last night by a vote of 59 – 39, filled with sweeping changes for the financial world. The Bill must still be reconciled with the one passed by the House before being sent to the President to sign into law. The purpose of this Bill is to address the financial crisis that had occurred in 2008. There is actually a committee that is studying what had caused the financial crisis, and they are due to present a detailed report and explanation by the end of this year.

One of the reasons why this Bill is so controversial is that many feel it would be prudent to wait for these findings before passing regulation. Either way – these new laws often wind up having many unintended consequences which will have to be dealt with down the road. There are also many potential impacts on the mortgage industry – and it is very important to stay tuned to our regular legislative updates coming from our partnership with Bill Kidwell and IMMAAG.

The Treasury will auction off $42B of 2-Year T Notes, $40B of 5-Years and $31B of 7-Years set for next week, which is $5B less than similar offerings as a total.

For now, we can continue to recommend a Floating bias as the direction in Stocks plays out.

Risks favor: Floating

Current Price of FNMA 4.5% Bond: $101.78, +19bp

The US Bond market continues to attract buying interest as a safe haven from the ongoing problems in Europe. And this morning, a weak Empire State Manufacturing Index is helping Bonds retain their bid higher. The Empire State Index came in at 19.11, well below the 30.0 expected – but a deeper look into the report does reveal a few items that are not so good for Bonds. The Employment reading climbed to the best level in six years, showing that there is hiring in this sector of the economy. Additionally, the inflation-measuring prices paid component rose to a 44.7 reading, the highest level since September 2008. So while the headline number caused Stocks to move lower and Bonds to retain their current high ground – some of the underlying data may weigh on Bonds as the day progresses.

Today also brought March’s Treasury International Capital (TIC) Report, which measures foreign investment in US securities – and shows exactly who has been buying our Bonds and pushing prices higher of late. China, for the first time in six months, was a net buyer of our debt, adding $17.7B to their present holdings. Chinese holdings now total $895B, and they remain the largest creditor to the US. Japan, the second largest holder of US Treasuries, added $16B to their portfolio during March, bringing their total holdings to $785B. The report also showed a pickup in foreign buying of Mortgage Backed Securities. During March, a net $22B in MBS was purchased, up significantly from February’s $2B.

The turmoil in Europe and weakness in the Euro is causing investment dollars to flood into the US, even though the yields are already quite low. The dramatic increase in foreign purchasing is making up for what the Fed would have been buying in MBS. Add to this US investor dollars that are now being put to work back here in the US, instead of riskier European options, and it’s clear to see why Bond prices have performed so well of late. The important thing to remember is that the improvement in Bonds is not a fundamental one – it is a trade. There is a big difference between fundamental investments and temporary trades. Trades move quickly and eventually reverse in an ugly way. We’ll need to be on guard for this eventual reversal in Mortgage Bonds. For now, we’ll enjoy the move higher.

Kansas City Fed President Thomas “BBQ” Hoenig – the lone dissenter during the past three Fed meetings on the “extended period” language – offered a few thoughts over the weekend. “We’ve gotten through the crisis. We are not out of the woods, the economy isn’t booming, but we are now in a position where we ought to be thinking about the long run. That’s what central banks should do.” Mr. Hoenig has been very vocal on his concerns about inflation over the longer term, as a result of keeping rates too low for too long. There is a big Fed meeting coming up on June 23rd, and we’ll see if more Fed members side with Mr. Hoenig.

We will Float and watch carefully in a very volatile environment with prices trading near resistance.

Risks favor: Floating

Current Price of FNMA 4.5% Bond: $101.47, +25bp

The problems in Europe continue to dominate the headlines, and influence market direction around the globe. Skepticism over whether Greek austerity measures will take root and if the European bailout plan is just a temporary band-aid rather than a solution, are pressuring the Euro lower once again. At $1.24 per each Euro, the price is well off where it was a few months ago, when it cost over $1.60 for each Euro. When the Dollar was weaker, it made our imports more costly, as well as travel to Europe more expensive. But it also made our exports far more attractive to foreign purchasers, and that has helped many of the large multi-national US corporations.

As this situation is now reversing, it will likely have an adverse effect on those same multi-national corporations, which is contributing to another Stock market decline today. As we know, when Stocks decline, Bonds are typically the beneficiary. Today is no exception, as Bonds are improving from a weaker Stock market and from the global viewpoint that the US is a safer and more stable place for Bond investments. Mortgage Backed Securities are starting the day sharply higher, but will still need to contend with strong ceilings of resistance.

You may have noticed that the price of gasoline at the pump has come down in the past week, and it may come down a little further still. This is a result of the strengthening US Dollar, as investors park their money in US Dollar denominated securities like our Treasuries. Again – this is being done as global investors see US debt and securities as a safe haven from the problems in Europe. Oil, which was trading at $86/barrel just last week, is now trading at $74/barrel.

Today’s economic headlines showed that Retail Sales for April rose by 0.4%, double the expectations of 0.2%, and representing the seventh consecutive monthly increase. When stripping out autos, the figure was 0.4%, just below the 0.5% expected. The report can be volatile month to month, but the recent string of improving reports does signal that the consumer is starting to spend more money.

Consumer Sentiment rose to 73.3 during early May, up from last month’s reading of 72.2 – and was essentially in line with expectations. By way of comparison, the historical average of the Consumer Sentiment is around 87. The lowest on record was 43, hit in December of 1974…and during the most recent recession, the index hit a low of 63 in April 2008.

Industrial Production and Capacity Utilization were both reported in line with expectations as 0.8% and 73.7% respectively. With the uncertainty in Europe driving the trading activity of late, this benign news did little to influence the market.

Bonds are off to the races today, so we will obviously continue our Floating stance. But a look back to last week shows that Bond prices pulled back intra-day from levels similar to where they are now. We’ll need to keep an eye on this as the day progresses.

Risks favor: Carefully Floating

Current Price of FNMA 4.5% Bond: $101.41, +12bp

One Trillion doesn’t go very far these days. Just yesterday, news that the ECB had set up a $1 Trillion bailout for struggling Eurozone countries, was initially viewed as a positive measure and helped push the Euro and Stocks around the globe higher. But this morning, that boost of confidence in the Euro is waning. In fact, the Euro is now trading lower than where it was before the bailout was announced. Now there is concern about how these already financially strapped countries will pay for all this additional debt…hmm, sounds pretty familiar to what we said just yesterday. Mortgage Bonds are just slightly higher on the news and well off their best levels seen earlier in the day.

We have talked many times about how an extended period of accommodative monetary policy by a central bank can spur inflation. And this morning, China, which went through a period of very relaxed lending standards to boost their economy is now seeing year over year inflation at the highest rate in 18-months. This is troublesome because inflation in China could spill into the US, as the increased cost of their goods could translate into higher import prices paid for their items. This news is likely one reason why Bond prices have been unable to make any meaningful ground this morning.

Another reason why Bonds have not made a meaningful advance this morning is the overhang of Treasuries to be auctioned this week. At 1:00pm ET today, we get the results from the $38B 3-Year Note auction, which will be followed by more auctions over the next few days.

During the past five sessions, Bond prices have been extremely volatile but have somehow managed to hug the dual ceiling of resistance. This is where Bond prices are also trading so far this morning and tells us that these ceilings are formidable. We can begin the day by floating, but the odds are that prices will eventually move back under these ceilings.

Risks favor: Very Carefully Floating

Current Price of FNMA 4.5% Bond: $101.53, +3 bps

Wow! It was a wild ride yesterday and the highly volatile activity in the market is continuing so far this morning. Let’s start with a quick recap of yesterday’s activity. Stocks took a nosedive for a brief period yesterday afternoon plummeting by 998 points on the Dow, with over 600 points of that drop occurring in minutes. Then just as quickly, stocks recouped more than 600 points of their losses and still ended the day significantly lower. What caused this wild 15 minute span? Investigations are underway and accusations range from an errant trade to a fat finger, with both the NASDAQ and NYSE pointing blame at each other. So what’s a fat finger? This is when a wrong button is pressed or too many zeros are hit on a sell order – you get the picture. But we think that this is a result of the type of orders that are electronically submitted at a mind boggling pace. Remember that computers do the vast majority of the trading, which is one reason why technical analysis is such an effective way to forecast the market. If you’ve ever traded a stock, you know there are two types of orders. There’s a limit order – this is where you put in an order to buy or sell a security but you “limit” the price that you will be willing to accept. The risk with a limit order is that your order does not get filled because there are no takers at the limit price you have outlined. The second type of order is a market order – this is where your order is put in as a buy or sell at the “market price”. In other words, you will take the best available offer to fill your order.

Yesterday with stock prices already down significantly, many computer triggers for sell orders were hit as technical floors were broken. Computers started executing sell orders at “market price”. And with the enormous flood of market sell orders coming in, bidders pulled back. There were very few bids to satisfy the sell orders. And remember with a market sell order, the computer will keep seeking out the next available bidder in an effort to fill the order…no matter how low that bid is. One extreme example was in the trading of the stock Accenture (NYSE: ACN). ACN went from $40 down to $0.14 (yes, 14 cents), then came all the way back to close at $41.09. This is the danger of market orders.

The wild stock trading and big slide in stock prices made for a big up day in the bond market. Mortgage Bonds were one of the beneficiaries and had soared up as high as 150bp. Later in the day, Mortgage Bonds still closed to the upside but were about 100bp lower than their best levels.

This morning Bonds have been trading in a very wide range already. At one point Mortgage Bonds were down 50bp, although they are currently trading closer to unchanged levels. We expect this volatility to continue throughout the day for both Stocks and Bonds in a very jittery environment.

It’s unusual for the monthly Job’s Report to be out of the spotlight, especially when the Jobs number is much better than forecast. And that’s exactly what we got today. There were 290,000 jobs created in April, well ahead of estimates for 187,000 new job creations. The increase was the biggest rise since March of 2006. In addition, the revisions for February and March were +121,000. There were 66,000 temporary census workers included in the 290,000 increase. Since December, Non-farm payroll employment has expanded by 573,000. The vast majority of job growth occurred during the last 2 months. The Household Survey was also favorable, showing a gain of 550,000 Jobs.

The Unemployment Rate ticked up to 9.9%, a move up from the current 9.7% rate. The main reason for this tick higher in the Unemployment Rate was the increase in the labor force of 805,000. As we have often discussed, an unemployed individual who does not look for a job for 4 weeks is removed from the labor force. While the rationale for this is highly debatable, the move back into job search mode for these people can cause the Unemployment Rate to rise even when more jobs are being created.

The German Government voted to approve the bailout for Greece. There had been some doubts on Germany’s approval. This may unwind a bit of the flight to safety in US Bonds.

We will start the day by carefully floating in a very volatile environment. It’s easy to get whipsawed in a market like this, where there are big swings in both directions. Yesterday’s lock advice appears to have been prudent. On new transactions, we will wait and see how prices hold up. Given the market’s tentative nature, it would not be surprising for bonds to deteriorate.

Risks favor: Locking Ahead of Tomorrow’s Jobs Report

Current Price of FNMA 4.5% Bond: $101.12, +3bp

Bonds started the day to the upside but in an already volatile session, are now trading near unchanged after stepping into negative territory. The erratic behavior of the Bond market is understandable, with many opposing forces tugging at Bonds from both directions. The latest push higher for Bonds has been fueled by a Stock market selloff, where investors are parking the sale proceeds into Bond instruments. Additionally, the US is being viewed as a safer place to invest than Europe , which is evidenced by the Euro hitting a 14 month low against the Dollar. The situation in Greece has reached very troublesome levels, with riots and deaths now grabbing the headlines, as public workers do not want to accept some of the cutbacks needed to help Greece get on firmer economic footing, which is also a conditional requirement for the ECB and IMF’s bailout. But on the other side of the trade is the sentiment that the economy is improving, US debt is soaring, and rates will certainly be on the rise. This makes for a very difficult trading environment, as important headlines like today’s Initial Jobless Claims do not result in normal market reactions.

Speaking of Initial Jobless Claims, they were reported this morning at 444,000, a touch above the 440,000 expected. Continuing Claims, or individuals receiving unemployment benefits lasting up to 26 weeks, fell by 59,000 to 4.6M. But those who have maxed out their Continuing Claims benefits can claim emergency benefits (Emergency Unemployment Compensation), which can extend them to a total of 99 weeks of benefits. The number of individuals that fall into that category is a staggering 5.3M, an increase of 154,000 from the prior week.

Productivity in the First Quarter rose 3.6%, better than the 2.4% that was expected. The rise was the smallest gain in a year and comes after a 6.3% gain in the Fourth Quarter of 2009. It is not surprising to see a big fall off in productivity as the last quarter’s scorching 6.3% rise came off of very low levels.

The latest Treasury auction amounts were announced yesterday, but the size was trimmed from the first quarter. The government will sell $38B 3-Year T-Notes on Tuesday, $24B in 10-Years on Wednesday, and $16B in 30-Year Bonds on Thursday. This will make for some interesting and volatile market activity next week.

The European Central Bank left its benchmark interest rate at 1% as the debt problems in Europe intensify. As we mentioned earlier, the ongoing problems in Europe have supported the US Bond Market.

Jobs Report Strategy

There is a lot of evidence that the economy is improving, and while the labor market is still weak, it appears to also be improving. The consensus for tomorrow’s Jobs Report is for 187,000 new jobs to be created, with an Unemployment Rate holding steady at 9.7%. We think the stage may be set for a slightly better number than forecast, and with Bonds in overbought territory, they are ripe for a sell-off on a good number.

If the Jobs number is below expectations, Bonds will get a modest boost…but a Jobs number that beats expectations could send prices much lower quickly, from their present levels. This is why we are advising to Lock in advance of tomorrow’s Jobs number.

Risks favor: Very Carefully Floating

Current Price of FNMA 4.5% Bond: $101.19, +19bp

Mortgage Bonds are trading higher so far today, but off their best levels. The Bond market continues to attract investment dollars as a safe haven from the ongoing – and increasing – uncertainty over the situation in Greece.

Today, over 40,000 Greeks are rioting in the streets, engaging in violent protests against the Greek government’s proposed austerity measures. This has spooked the Stock market, and is helping Bonds move higher. Further – another troubling headline is coming from the Eurozone today, as Portugal is apparently facing another potential downgrade on their debt – prompting investors to move even further into the safe haven of Bonds.

Market volatility has been sharply higher of late, and the VIX volatility index – which measures volatility in the Stock market – has risen very sharply over the last four trading sessions. The VIX is a widely used measure of market risk, and is often referred to as the “investor fear gauge.” One look at the Bond Page shows you how the volatility in Stocks is impacting Bonds, as they have traded in a wide 44bp range just this morning.

While Bonds are higher – we need to exercise great caution. Bond prices are near resistance marked by the highs seen back in February and March. Additionally, Bonds are now in an overbought state, making them ripe for a reversal lower.

In economic news this morning, ADP’s read on employment for April showed 32,000 private jobs created, essentially in line with expectations, and representing the third straight month in positive territory. Now remember – ADP is not always in line with the official Jobs Report, which is due to be released this Friday. Expectations for the Jobs Report are to show 187,000 new jobs created. Tomorrow we will lay out our Jobs Report Strategy, headed into that important release.

The Institute of Supply Management Services (ISM) report for April came in at 55.4, very close to expectations. The market had little reaction to either the ISM or ADP reports being released, in light of the wild conditions taking place in Greece and Europe overall right now.

For now, we can continue to recommend a bias towards Floating, as the safe haven play could well continue as the troubles in Europe persist. That said – we need to be very cautious, as the Stochastic Chart on the Bond Page clearly shows that Bonds are in an overbought state, as well as nearing tough overhead resistance.