D Word Could Change Direction of Rates

"THE IMPORTANT THING IN THIS WORLD IS NOT SO MUCH WHERE WE STAND, AS IN WHAT DIRECTION WE ARE MOVING." Oliver Wendell Holmes. And when it comes to the direction our economy may be moving, there was some surprising news from the Fed last week that the "Minutes" from their October meeting revealed.

After years of being concerned about inflation, the Fed is now concerned about deflation. So what exactly is deflation? Deflation is when prices drop, which generally is due to lack of demand, and therefore lack of pricing power. With the economy slowing down, we are hearing economists forecast that we may be in for a deflationary recession. In a deflationary environment, investors flee into fixed instruments like Bonds, because the fixed payment received would actually buy them more goods and services over time as prices decline.

So what does this mean for home loan rates? Remember, home loan rates improve as Bond pricing moves higher - and more demand for Bonds would mean higher prices for Bonds. In the spring of 2003, when Alan Greenspan uttered the "D" word, deflation, Bonds rallied 400bp in just a few weeks, bringing a significant drop in home loan rates. Of course, the economy is different right now, but as more money may be headed towards Bonds in a deflationary environment, we could again see a significant improvement in home loan rates down the road.

On the inflation front, last week's Producer Price Index indicated that wholesale inflation plummeted last month - by the most since records began in 1947 - largely due to declines in energy prices. In addition, the Consumer Price Index showed that inflation at the consumer level fell by a record 1.0%, thanks again to lower costs of energy.

When it comes to the direction the economy is heading, the week did end with some hopeful news. Federal Reserve President Jeffrey Lacker said that an economic recovery could begin in 2009 as low interest rates, low energy prices, and less drag from the housing sector may shore up spending. In the meantime, Bonds and home loan rates spent much of last week trading near a key level of technical support called the 200-Day Moving Average, finally moving and staying above this level on Friday. As a result, Bonds and home loan rates ended the week unchanged to slightly better than where they began.

Mortgage Market Update

MMG Update + By The Numbers - Monday, November 17, 2008 10:43am ET

Current Trend Direction: Sideways

Risks favor: Carefully Floating

Current Price of FNMA 6% Bond: $101.12, Unchanged

Bad news continues to infiltrate the markets today and Mortgage Bonds, currently near unchanged levels, are already far below where they were earlier. Stocks around the globe are lower fueled by worldwide recession fears. Japan became the latest economy to fall into a recession.

The New York Empire State Manufacturing Index came in near estimates at - 25.4, representing lowest reading since records began in 2001.

Banking giant Citigroup announced it will lay off 50,000 people on top of the 23,000 jobs they cut earlier this year. These heavy cuts would leave the second-largest US bank with about 300,000 jobs worldwide.

Our man on the Street, Joe Oakes, says that top executives at Goldman Sachs have decided to forgo their 2008 bonuses in the midst of one of the worst years on Wall Street in memory. Seven top executives have asked the compensation board committee to grant them no bonuses along with CEO Lloyd Blankfein. Blankfein's bonus in 2007 was $70 million...he'll have to struggle to make ends meet with that.

Industrial Production showed a 1.3% rise, higher than the -0.1% expected. September's -2.6% reading was revised lower to -3.7% making it the largest monthly drop in industrial production in over 60 years.

Mortgage Bonds continue to linger near the 200-day Moving Average for the 9th consecutive trading session. Bond prices attempted to rally earlier and moved up to touch exactly on the 200-day MA, but were turned lower as sell programs kicked in. For now we can float - but be ready to lock should pricing drift further to the downside and away from the 200-day MA.

This Is Not the Great Depression

This Is Not the Great Depression

Comparing the current crisis to the Great Depression is just plain wrong, say historians and veteran financial experts.

"The nomenclature of the word 'crisis' has cheapened," says Roy Smith, a professor at New York University's Stern School of Business and former partner at Goldman Sachs .

“The Great Depression had thousands of banks failing and people losing their life savings, 25 percent unemployment and social unrest and tent cities of the poor," says Allan Sloan, Washington Post and Fortune magazine columnist.

"With just 6 percent unemployment, we are having a debate as to whether we are even in a recession," says Richard Sylla, professor of the history of financial institutions and markets at New York University.

Source: Reuters News, Robert MacMillan (09/22/08)

Morgage Update: Stocks and Bonds

The recent euphoria in the Stock market continues, and the word in the trading pits is that perhaps the credit crunch is over. Today, we are hearing about more financial institutions raising capital, and this time it is Washington Mutual saying that it has investors injecting $5 Billion in cash. Traders are reading the recent investments and capital raising in the financial sector as a sign that the worst days of the credit crisis may be in the rear view mirror. As a result, Stocks overall are trading higher, and as money flows out of Bonds and into Stocks, this is hurting Bond prices a bit this morning.

Today kicks off the beginning of earnings season for Stocks, which may have the potential to add to the euphoria or change the mood to a negative one depending on the results. With the scent of recession in the air, the quality of corporate earnings and especially future guidance will largely influence the direction of both Stocks and Bonds in the coming days. If corporate earnings are reported weaker than expected, Stocks may come off the happy gas and head lower, which would provide a boost to Bonds.

Mortgage Bonds, while trading lower, are improved from the worst levels seen earlier in the day. Additionally, prices remain well above support at the 50-day Moving Average. For now, we will continue to Float and give Bonds a chance to further improve - but be ready to Lock your mortgage rate if things turn sour.

Measure Twice-Cut Once. What happened?

MEASURE TWICE...CUT ONCE. And like this old saying advises, Fed Chairman Ben Bernanke and his Federal Open Market Committee probably measured their decision quite a few times before making their recent ..50% cut to the Fed Funds Rate. But if the Fed's history of making cuts and hikes in cycles continues - this cut is probably not a "one and done".

Here's what the Fed had to say as they announced the cut: "Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time." This means that the Fed will take whatever steps are necessary in terms of rate cuts to try and prevent a possible recession, so long as inflation remains in check.

Initially, both Stocks and Bonds rallied on the comforting words from the Fed - but as Bond Traders analyzed the potential future impact of the Fed cut over the following days, they started selling off Bonds with both hands, causing fixed home loan rates to rise by ..125 to ..25%, actually higher than where they stood before the Fed Rate Cut. What happened?

Traders realized that a Fed Funds Rate cut could encourage increased spending by consumers and businesses, as borrowing costs will now be cheaper for Home Equity Lines of Credit, consumer loans like car loans and credit cards, and business loans as well. In turn, increased spending can translate into increased inflation in the long run - and inflation is bad news for Bonds. Bonds deliver a fixed rate of return, and the value of that return is eroded by inflation. So Bond Traders sold, the price of Bonds moved lower, and home loan rates moved higher as a result. Counterintuitive to many...but its reality, and now you understand what many do not - including much of the mainstream media

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