Risks favor: Floating – but Carefully, as Prices are Near Resistance
Current Price of FNMA 4.5% Bond: $100.72, +19bp
Mortgage Bonds are trading higher and up against tough layers of resistance at the 50, 100 and 200-day Moving Averages. A look at the Bond page shows that prices have been testing this tough ceiling each of the past four trading days, so it will be important to follow how the Bond reacts to this ceiling heading into the weekend.
The saga in Greece continues. It does appear that Greece will receive some sort of aid package in the next few days, but it is not likely to come without a lot of drama. In order for Greece to receive an aid package, they must lay out an aggressive plan to significantly cut their budget deficit…and there are many protests in Greece against these austerity measures.
The Commerce Department reported today that the first, or Advanced, reading on Gross Domestic Product (GDP) for the 1st quarter of 2010 showed that the economy grew 3.2%, after a 5.6% growth rate in the 4th quarter of 2009. The 3.2% reading was slightly below estimates of 3.3%, but was the 3rd straight Quarter of gains.
Inflation readings within the report remained tame, giving the Fed cover to keep interest rates low, as inflation appears to be subdued. The Core Inflation Rate, which strips out food and energy, rose 0.6% after a 1.8% increase in the 4th quarter of 2009, and was the lowest level that has been seen in fifty years. Let’s remember that this may be misleading, as the gauges and measurements for inflation have been tweaked many times during this period – so there is not an “apples to apples” comparison. The price index for personal consumption expenditures rose by 1.5%, following a 2.5% gain in the fourth quarter.
Consumer Sentiment arrived at 72.2, a bit better than expectations of 71, and the Chicago PMI also beat expectations, coming in at 63.8, above estimates of 59.9. Surprisingly, Bonds shrugged off the news and remain to the upside, but still testing resistance. We’ll begin the day by Floating, but will watch the tug of war at resistance very carefully.

Risks favor: Carefully Floating

Current Price of FNMA 4.5% Bond: $100.41, +3bp

Initial Jobless Claims were a little disappointing and this helped Bonds hold their ground. This past week, 448,000 new jobless claims were filed, just above expectations of 445,000. Continuing Claims came in at 4.65M, essentially unchanged. And 5.2M people are claiming EUC (Emergency Unemployment Compensation), a decrease of 146,641 from the prior week. At this stage in the economic recovery, the weekly Initial Jobless Claims readings we are seeing are still pretty high, and suggest that businesses are both reluctant to hire and are looking to trim overhead.

Yesterday, the Fed left rates as is and the Policy Statement had no real meaningful change, including no changes to the important “extended period” language. Also, St. Louis Fed President Thomas “BBQ” Hoenig, remains the lone dissenter on the language and wanted to have it changed. The Fed made no mention in their Policy Statement about selling any of their Mortgage Backed Security holdings, although it may have been discussed, and could come up when the Meeting Minutes are released. There is growing concern that if the Fed doesn’t begin selling some of these MBS holdings by 2011 that additional asset bubbles may arise. It’s likely that the Fed will look to sell a meaningful chunk by year end.

Concerns about European sovereign debt have created a flight to quality trade, where investors lose some confidence in European debt instruments, and move their holdings over to US securities, which are viewed as a safer bet. This morning, European and German officials assured markets they were working quickly on approving a bailout for Greece as they try to keep the country’s debt crisis from dragging others into a continent wide financial meltdown. Additionally, Spain’s Finance Minister indicated that they would be able to cover their debt obligations – at least until July – and would not be asking for any aid at this time. These soothing comments may slow down the flight to quality that has benefitted US Bonds of late. But the situation appears to be quite fluid, and can quickly change.

The results of today’s record $32B 7-Year Note auction will be released at 1:00pm ET, and this will be closely watched as the last 7-Year auction did not go over that well. This week’s auction results overall have not been good, so stay tuned later today.

We can start the day by Floating, but be ready to Lock should the 7-Year auction results come in weaker than anticipated.

Risks favor: Carefully Floating into the Fed Announcement Later Today

Current Price of FNMA 4.5% Bond: $100.50, -23bp

Yesterday, Standard & Poor’s Bond rating agency downgraded the debt of Greece to “junk” status. This news disrupted the Stock market, and global Bond investors sought the safe haven of the US Bond market. This sparked a huge rally in US Bonds, including Mortgage Bonds.

The lack of confidence in Greece’s ability to repay their debt has pushed yields on their 2-Year Notes to a whopping 18% – and by comparison, our own US 2-Year Notes are yielding just over 1%! This is why credit downgrades are such a concern, and why the warnings from Moody’s about the US overspending should be paid attention to. With yields on Greek debt at such high levels, it is attracting some money back from investors willing to take on greater risk for greater reward. As a result, we see a bit of a reversal of yesterday’s action in the Bond market.

With the second day of the Federal Open Market Committee meeting underway, the Policy Statement and Interest Rate decision is set to be released at 2:15pm ET. We still see no chance of a hike to the Fed Funds Rate at this meeting, but the Policy Statement will draw the attention of the entire world. The “extended period” language remaining in the Statement has been hotly debated amongst Fed Members, the media and arm chair economists, so it will be interesting to see if there are any tweaks today.

Additionally – Kansas City Fed President Thomas “BBQ” Hoenig has been the lone dissenter to the language remaining in the statement, but some of his colleagues at the Fed have voiced concerns about inflation in their recent speeches. Will anyone join “BBQ” in his formal dissention to the language? St. Louis Fed President James “Raging” Bullard has expressed concern with the language, and there has recently been some positive economic data. Strong earnings, a stronger Stock market, better consumer confidence and housing numbers may all be enough to sway some Fed members already on the fence.

We know that a removal of the “extended period” language will have an adverse effect on our rate sheets, and we do have to be on guard this afternoon, as that is a real potential risk. That said, we think the Fed will likely stand pat until their next meeting on June 22nd and 23rd, which will give them the benefit of more economic data, and especially two more Jobs Reports, as well as a look at the housing market, post-Tax Credit incentives.

Another topic that is likely to be discussed during this current meeting is the timing of the Fed selling off some of their huge holdings of Mortgage Backed Securities. There is growing speculation that this will occur sooner rather than later, perhaps as early as the 3rd Quarter of this year. This will be yet another headwind for interest rates during the coming year.

At 1:00pm ET, the Treasury will sell a record $42B in 5-Year T Notes. This comes after yesterday’s $44B in 2-Years that produced not so stellar results.

Bond prices are now trading near an important ceiling at the 50-day Moving Average. We would like to be patient and Float into the Fed Meeting, but be mindful of the Auction at 1pm ET, as well as the overall turbulent market conditions which could put us in reprice territory, even before the Fed Meeting.

Risks favor: Start day by Carefully Floating

Current Price of FNMA 4.5% Bond: $99.94, -28bp

Mortgage Bonds are trading lower, after yesterday’s failed attempt to break above the strong ceiling of resistance at the 50-day Moving Average and recent price highs. This morning, a look at the Bond Page shows that prices opened well below yesterday’s closing price, and even below the 25-day Moving Average. This “gap” lower tells us there was heavy selling pressure before the market even opened…and Bond prices were forced lower immediately in order to attract buyers to start the day.

The saga in Greece continues. After yesterday’s headline that the country’s past budget deficits may be worse than originally reported, this morning, Greek Prime Minister George Papandreou has asked the European Union and International Monetary Fund to activate the huge $45B Euro ($59.9B US Dollar) bailout that has been raised for the country. This news is relieving some of the uncertainty in the markets, but this story is far from over – as Greece will need to take some dramatic measures to bring their budget deficit to a significantly lower level.

In economic report headlines, Durable Goods Orders for March fell by 1.3%, well below the 0.1% increase expected. The drop was attributed to a decline in aircraft orders, and when stripping out transportation, new orders rose by 2.8%, far better than expectations of 0.7%, representing the fastest growth rate since December of 2007. Durable Goods Orders are volatile reports month to month, so we can’t read too much into one report…and we also must consider that these numbers are coming off of very low levels, so it is easier to see sharp increases. Mortgage Bonds remained lower on this news.

New Home Sales for March were reported this morning, and very clearly, the First Time Home Buyer stimulus pushed buyers into action. 411,000 New Homes were sold, which was a huge increase from last month’s upwardly revised 324,000 reading. The pace of sales also spiked, thus pushing the inventory of unsold new homes down to a 6.7 month level, far below February’s 9.2 month reading. Weather also likely played a big part in this improved number as we saw plenty of snowstorms throughout the country in February, helping the pent up demand be seen in March’s numbers. It will be interesting to see how future numbers fare once the government stimulus – the Tax Credit which expires next week – is removed.

Yesterday, the Treasury announced it will unload a whopping $129B of debt next week in 2, 5 and 7-year Notes. This supply could be a headwind for Bonds next week.

And speaking of supply…as we have been reporting, the Fed is considering the possibility of reducing its massive $1.2 Trillion Mortgage Backed Security (MBS) portfolio by initiating some asset sales, which may now start as early as the third or the fourth quarter of 2010. As we have discussed several times in our Daily Updates, when the Fed starts to move on selling some of their huge holdings of MBS – rates will be on the rise as even more supply comes into the market.

Today, we will start out with a Carefully Floating bias, but be ready to move towards a Locking stance should Bonds sour later in the day.

Risks favor: Carefully Floating

Current Price of FNMA 4.5% Bond: $100.47 +3bp

A worse-than-expected Initial Jobless Claims Report and weakness in Stocks are giving Mortgage Bonds a slight boost so far today. Bond prices are now trading near a thick ceiling of resistance formed by the 50 and 200-day Moving Averages, as well as recent price highs.

Stocks are taking a hit this morning on news from European statistics agency, Eurostat, which reported that Greece’s budget deficit for 2009 was worse than previously reported, and that it could likely be revised even further…and not for the better. This is causing uncertainty and anxiety in the markets, as Greece is in the midst of negotiations with both the European Union (EU) and the International Monetary Fund (IMF) to receive a $45B aid package in lieu of making drastic cuts to their budget and spending.

President Obama will be in New York City at Noon ET pushing the new Financial Reform Bill – and as we’ve been discussing, it is “coincidentally” during a time when Wall Street giant Goldman Sachs has been accused of fraud by the Securities & Exchange Commission. This will be very interesting, and very important to watch. As we have discussed numerous times – having politicians involved in the US monetary and financial systems is a very frightening prospect. At the moment, Stocks remain under pressure and are likely a little jittery headed into his talk.

Initial Jobless Claims came in at 456,000, slightly higher than expectations of 450,000. Continuing Jobless Claims fell by 40,000, down to 4.65M. Additionally, 5.34M people are claiming EUC (Emergency Unemployment Compensation) benefits, representing a huge decrease of over 500K from the prior week. But as usual – looking past the headlines reveals something quite interesting that isn’t making the front page. A deeper look into the report shows there was a budget dispute in Congress which created a lull in benefits – and therefore caused the big drop off in the number of folks receiving these EUC benefits. The dispute has since been resolved, so look for the Emergency Claims to tick back up in the coming weeks. Overall, the weekly Initial Jobless Claims readings remain stubbornly high, and we need to see a significant drop in these numbers in order to start making a dent in the Unemployment Rate.

The March Producer Price Index (PPI), a gauge of inflation at the wholesale level, rose to 0.7% last month, above the 0.5% that was expected. This left the year-over-year headline PPI at a beefy 6%, the highest reading since the fall of 2008. The main culprit to the spike in the PPI was a 2.5% rise in wholesale food prices, the largest monthly gain in 26 years. The Core PPI, which strips out volatile food and energy, was inline at 0.1% and up a much more modest 0.9% year-over-year. As we have discussed in the past, an increase in producer costs don’t necessarily trickle down to the consumer – and this was evidenced by last week’s relatively tame March Core Consumer Price Index (CPI) reading of 0.0%. All in all – Bonds didn’t react too much to this report.

Existing Home Sales were reported at 5.35M, higher than expectations of 5.28M. The inventory of unsold homes fell to an 8 month level from a prior month’s reading of 8.6, thanks to a jump in the pace of sales, likely sparked by the Home Buyer Tax Credit incentive, which is nearing an end. It will be interesting to see how this report fares in future months as the Tax Credit expires.

At 11am ET, the Treasury will announce the size of next week’s 5-Year TIPS, 2, 5 and 7-Year T Note auctions on Monday, Tuesday, Wednesday and Thursday. This announcement could influence the markets, especially with prices near a tough ceiling of resistance, so be on guard.

For now, we can continue to Cautiously Float, but be mindful of the thick ceiling of resistance and upcoming news items later today which could certainly change the present sentiment.

Risks favor: Carefully Floating

Current Price of FNMA 4.5% Bond: $100.31, +12bp

Mortgage Bonds are trading higher and once again testing a ceiling of resistance at the 25-Day Moving Average. There are no economic reports due for release today, so prices could be pushed back lower from this resistance – stay tuned.

Corporate earnings reports were a mixed bag this morning, with Dow components McDonald’s beating estimates, while Boeing’s revenue was a bit less than expected. Morgan Stanley beat expectations, but Wells Fargo’s profit fell. The big winner was Apple Inc., blowing away Wall Street estimates – and it is being reflected in the stock price of Apple, (AAPL) which is trading near record highs of $260. Overall, the entire Stock market is modestly higher so far this morning.

CNBC reported this morning that the government has testimony that contradicts the SEC’s own case against Goldman Sachs. And speaking of the SEC, you may recall that the SEC was likely a key factor in the financial meltdown, due to their lack of responsiveness in addressing the mark-to-market situation. Ultimately it was remedied by public and political outcry, what has since resulted in a stabilization of the financial market.

Staying with the SEC theme, last Friday – the very same day that the SEC unexpectedly announced its Goldman lawsuit – the SEC’s inspector general released exhaustive reports on the agency’s failure to investigate alleged fraudster R. Allen Stanford, following their gross mishandling of the Bernie Madoff situation. This is yet another enormous blemish on the SEC, and there are many questions as to the timing of the release of the Goldman charges. Since the Goldman situation grabbed the spotlight and virtually all the media discussions, the damning inspector general’s report was lost, amidst the market volatility and media frenzy. Was this done intentionally by the SEC to achieve this exact result? This is what many people are asking.

And this morning, Congressman Darrell Issa said on CNBC that the timing of the SEC charges smells fishy. Aside from the announcement coinciding with the release of the aforementioned damaging report on the SEC, Issa stressed the peculiarity of releasing this news during the trading day, which caused enormous market reaction, volatility and media coverage. These types of reports are almost always done outside of trading hours, as to not cause undue market consternation.

This also brought up the question of political motivation. Given that this suit is a civil one, the SEC has a wide window of when these charges could be brought about. And to time them in the midst of the Financial Reform debate brings the SEC’s already suspect intentions into even deeper question.

We will continue our Floating stance, and watch how prices behave near the 25-day Moving Average.

An inflation story worth following – the United Kingdom (UK) saw consumer price inflation in March rise to 3.4%, up sharply from a 3% reading in February. This is well above the government’s mandate of keeping inflation at 2% or below. Seeing that England is still trying to recover from a deep recession, their central bank is not in a position to hike interest rates at the immediate time. This could create a greater inflation problem down the road. The financial world has become quite small and interconnected. Higher inflation in the UK will lead to higher rates there and that will pressure rates in the US higher as well. As investors seek higher yield the US will need to stay competitive.

On Thursday at 11:00am ET, the Treasury will announce the amounts for the next round of auctions for next week. The offerings will be for the 5-Year TIPS, 2, 5 and 7-Year T Notes on Monday, Tuesday, Wednesday and Thursday.

Mortgage Bonds are trading near unchanged after closing above resistance at the 25-Day Moving Average on Friday. A look at the Bond page shows prices are now testing another layer of resistance provided by the 50 and 200-day Moving Averages, as well as recent price highs. With no high impact economic reports hitting the wires today, this ceiling of resistance may prevent Mortgage Bonds from following through higher on Friday’s strength, which was a result of weakness in the Stock market from the Goldman Sachs charges.

The Goldman Sachs story continues to unfold. On Friday, the Securities and Exchange Commission (SEC) brought on civil charges of fraud against Goldman Sachs, stating that the firm created and sold Credit Default Obligations (CDOs) tied to subprime mortgages without disclosing that hedge fund Paulson & Co hand picked the underlying securities. The problem here is that not only did Paulson & Co hand pick horrible sub-prime mortgage assets to be included in the CDO, but after picking these assets which had no chance of performing, they also bet against them – which means Paulson & Co was allowed this slam dunk trade, all with Goldman Sachs in the know.

European politicians are now calling for their own probe of the CDO dealings by Goldman…as well as looking into their role with Greece . There is speculation that the firm helped Greece mask the country’s true budget deficit through the use of sophisticated financial instruments. Goldman Sachs certainly has their hands full, and there are likely to be more investigations pending…remember, there is never one cockroach.

Goldman Sachs says the charges are “unfounded in law and fact”. And the timing of these charges being announced just as Congress is seeking to pass Financial Reform has raised more than a few eyebrows. Even former President Bill Clinton said on Friday said that the chances of Financial Reform passing had been about 60 – 70%, but with the Goldman Sachs charges being a “clincher”, chances are now closer to 90%.

This ongoing story and investigations will help Congress in passing financial reform, but one of the by-products of Financial Reform may be the stripping away of the Federal Reserve Bank’s independence. And as we have said many, many times before, having the Fed’s independence taken away would be awful for our country and economy. There has never been a situation in the history of the world where a good outcome resulted from politicians taking over the Central Bank. In fact, the only results have been disastrous, including hyperinflation.

Remember the famed quote of legendary economist Milton Friedman, “Inflation is a monetary phenomenon, but hyperinflation is always and everywhere a political phenomenon, in the sense that it cannot occur without a fundamental malfunction of a country’s political economy.” You may recall during Chairman Ben Bernanke’s confirmation speech, he talked in depth about the need to retain the Fed’s independence. Let’s all hope we never get to see politicians meddle with monetary policy.

Mortgage Bonds started the day to the upside, and made another attempt to break above the tough ceiling of resistance at the 25-day Moving Average. But as we have seen a couple of times this past week, prices were turned lower and back beneath the 25-day MA ceiling. But breaking news is just hitting the wires – the Securities and Exchange Commission (SEC) is charging Goldman Sachs with fraud on subprime mortgages. Stocks are reacting negatively on the news, which is giving Bonds a lift. Mortgage Bonds are now making another run at the 25-day MA ceiling.

Housing Starts for March rose to an annual rate of 626,000, higher than estimates of 610,000…and representing the highest level of Starts since November 2008. Housing Starts are up 20% from a year ago. Adding to the positive tone of the report was an upward revision to February’s release, which was revised to 616,000 from the 575,000 previously estimated. Building Permits, which are an indicator of future new construction, increased 7.5% in March, moving to a 685,000 annual rate, which was higher than the 625,000 expected. Overall this was a pretty strong report, and was likely fueled by improving weather conditions around the country. Housing Starts are a double edged sword…as seeing more new construction of homes is more representative of builders sentiment and speculation rather than actual purchases. As we know, builders have been wrong in the past. But still, it’s good to see that builders are optimistic. As we said, this good news cuts both ways. More new construction adds to an already bloated inventory, which may actually be more of a drag on housing.

Stocks were higher ahead of the Goldman Sachs fraud charges on strong earnings reports from both Bank of America and GE. But stock investors are very fickle when it comes to earnings. Last night, tech bellwether Google beat earnings expectations, but fell short in top line revenue. Wall Street is showing their discontent this morning by taking the stock down by 5%, or about $30. Exactly as we mentioned a few days ago – traders and investors are not just looking for cost cutting measures, but actual revenue growth.

Consumer Sentiment was reported at 69.5, well below expectations of 75.0. The drop in sentiment is due to consumers remaining worried about the job market and their personal finances. As talk of the economic recovery keeps being bragged about by politicians, the media and Wall Street…many Americans just aren’t seeing a change on “Main Street.”

Some potentially market moving Fed Speak at 12:30pm ET, when Kansas City Fed President Thomas “BBQ” Hoenig speaks – and is expected to discuss the reasoning behind his insistence that the Fed begin raising interest rates. In fact, Hoenig has been the lone dissenter to the “extended period” language in the Policy Statement for the past several meetings. We have been talking about the “carry trade” for some time, and how the low Fed Funds Rate and “extended period” language has fueled this trade. You may wish to revisit our Carry Trade Conference Call found in the Conference Calls Library under the Calls/Videos/Webinars tab to get a good understanding of how it works. Once the markets feel the Fed Funds Rate is on the rise, we will start to see an unwinding of the Carry Trade, which will put selling pressure on both Bonds and Stocks.

We can continue to Float, but will be very wary of overhead resistance, which could keep a cap on prices and potentially turn Bonds lower as the session plays out.

It’s Tax Day – so be sure to get your return postmarked by Midnight tonight!

Mortgage Bonds are near unchanged, and it is somewhat disappointing that prices were unable to make any meaningful gains in the face of this morning’s crummy Initial Jobless Claims report. And after a few days of losses, prices are in the midst of a wide trading range – so we’ll have to monitor the action closely.

Initial Jobless Claims were reported at 484,000, well above the 440,000 that were expected. Continuing Jobless Claims increased by 73,000 to 4.64 Million. And on top of that, the Emergency Unemployment Compensation (EUC) benefits – which are an extension above the normal 26 weeks of Continuing Claim benefits – rose sharply in the latest report. Although this is rarely reported in the media and difficult to find, we have uncovered that from the week ending March 27, those receiving EUC benefits rose by a whopping 262,000, bringing the total number of people receiving this extended unemployment benefit to a staggering 5.9M.

This is very troublesome for many reasons – the obvious massive cost of the program aside, receiving unemployment benefits for nearly two years clearly removes the desire and incentive for many people to look for work. And if they don’t look for work for four weeks, they are removed from the ranks of the reported unemployed, which fictitiously contributes to a lower than actual rate of unemployment. But there is a great deal of hidden damage being done as well – we all know how quickly things change in the workplace. Being absent for two years may cause a deterioration in skill levels, and put individuals behind the curve for a long time. We are not sure how this will play out in the future.

One additional note on these numbers – the Labor Department is saying that the weak Claims report was more “administrative than economic” and that the Easter holiday skewed these numbers. There seems to be lots of excuses, from the weather to Easter Bunny to justify some of the numbers that are being reported. It’s a little difficult to imagine why the Easter holiday would increase the number of people filing for Unemployment benefits. Any way you slice it – these numbers indicate that the labor market is still under pressure.

Manufacturing activity in the New York region continues to improve, as the Empire State Index rose to 31.86 in April, strongly up from the 22.86 reading for last month, and well above the 24.00 that was expected. New orders and shipments were strong while the number of employees is at its highest level in more than two years.

Capacity Utilization was reported at 73.2%, just slightly below expectations of 73.3%. Industrial Production somewhat conflicted with the activity reported in the New York region, as it came in at only 0.1%, which was far below expectations of 0.7%. The Philadelphia Fed Manufacturing Index was 20.2, meeting expectations. Upon the release of these reports, Mortgage Bonds improved slightly from their worst levels.

After a few days of Locking – we will start the day by Floating and monitor the situation carefully, particularly with the 25-day Moving Average just overhead. Let’s also be mindful that volatility has clearly increased without the Fed’s safety net.