Update 5/7/10
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.