Market Update

MMG Update - Friday, June 27, 2008 10:59am ET

Current Trend Direction: Sideways

Risks Favor: Cautiously Floating

Current Price of FNMA 6% Bond: $100.59, +19bp

On the heels of the Fed decision to leave the Fed Funds Rate unchanged, their favored gauge of inflation arrived this morning, the Core Personal Consumption Expenditure (PCE) reading. The Core PCE rose 0.1% during May, lower than expectations of 0.2% - which left the closely watched year-over-year Core inflation rate at 2.1%. This is outside the Fed's desired range of 1 - 2%, but tolerable in light of the ongoing inflation fears...which has to come as a relief to the Fed.

Also embedded in the PCE report are readings on Personal Income and Spending, which both grew at rates larger than estimates in May. The boost in spending was likely due to the stimulus checks that were sent out to many American taxpayers in the beginning of May.

Oil hit a record high of $142.26 this morning and the inflationary fears inherent in rising oil prices are keeping a lid on both Stocks and Bonds. Stocks have been downright ugly, as the Dow is poised for the worst June since the Great Depression. But at the same time, Mortgage Bonds haven't performed well either...inflation is bad news for both Stocks and Bonds.

The University of Michigan's Consumer Sentiment index fell to 56.4 in June, from 59.6 in May. It's the lowest since 1980 and the third-lowest reading in the 56-year history of the survey. Mortgage Bonds are being helped by this poor economic news.

The ceiling of resistance at $100.47 is being tested again, but has been difficult to break of late. This gives us extra reason for a cautious approach this morning, as we want to see if prices can break above this barrier...but also must remain on guard, because a reversal from this level leaves a long way down before the next floor of support. Take a look at the Bond Page, and you can see how Bond prices have been unable to overcome the $100.47 ceiling, even in the face of a nearly 400 point decline in the Stock market yesterday, which should have pushed some money over into Bonds. We can carefully Float for now, but be ready to Lock as this formidable level of resistance could push prices lower still.

It was a Fed day afternoon yersterday- now when you know what happened, see the thoughts before it happened..

It's a Fed day afternoon. And both the stock and bond markets will be reacting to the words and actions of the Fed at 2:15pm ET. Let's break down the important questions - Will it be a half or quarter point cut? And what will the Fed say about inflation?
Everyone seems to have an opinion. Some are saying the Fed should not hike because of inflationary fears and Dollar weakness. The weakness in the Dollar is assumed to be inflationary because it will cost more to buy imports.
Some say the the Fed is already late and needs to cut by 50bp to avoid a recession. Jobs are weak, inflation is tame, housing and mortgages are performing poorly.
Others, like us, think that we will get a 25bp cut - the first cut in four years. Additionally, the Fed will cite inflation as a concern but should acknowledge that it is presently contained. We see this as the best balance to slowly help the economy without being an inflation threat. The Fed should have a green light to cut because their favored inflation measure, The Personal Consumption Expenditure Index (PCE) is under 2%. The result should be that stock traders will be disappointed, as they want a 50bp cut. Bond traders would rather see no cut to protect inflation, but will live with the 25bp.
Then there is good old Alan Greenspan. Appearing to have camera withdrawal, Mr. G is soaking up any media opportunity to pump his new book. His comments undermine the excellent job that Ben Bernanke has done. In contrast to Greenspan, Bernanke has been correctly patient and waited for the previous hikes to bring inflation down to the Fed's target zone. It would have been likely that Greenspan would have hiked much more aggressively, sending the country into a nasty recession, with Greenspan's only answer being another series of panic cuts, which would cause another bubble.
In the last bit of inflation news before the Fed meets to decide monetary policy, the Producer Price Index (PPI) “fell off a cliff” with a reading of -1.4% in August. Lower food (-0.2%) and energy (-6.6%) prices during the month led the unexpected decline in the Index. After excluding volatile food and energy prices, however, the Core Producer Price Index rose to a greater than expected 0.2% on higher drug and auto prices. Economists were predicting the PPI to fall to -0.3% and the Core PPI to rise by 0.1%. Overall, the PPI data is favorable.
Technically, bonds remain in a holding pattern trending above key support provided by the 200-day MA at $100.12