Mortgage Market update for November 4th 2010

Current Trend Direction: Sideways to Higher

Risks favor: Locking Bias

Current Price of FNMA 3.5% Bond: $101.34, +44bp

Yesterday, the Fed announced the details on their upcoming round of Quantitative Easing, and were quite clear about what they will be buying, how much and when.  Slightly different than what the market had expected, they announced that they intend to purchase $600B in Treasuries, starting now and continuing through mid-2011, which equates to about $75B in purchases per month.  And note - this amount is in addition to the current program, where the Fed is reinvesting the proceeds from their existing Mortgage Bonds portfolio.  When you add in these purchases, it appears that the Fed will be buying a total of about $110B or so per month…or just under $1T by the end of June 2011.  That's some big purchasing.

And as you likely saw, the initial reaction in the Bond market was dramatic, to say the least.  Bond prices whipsawed higher and lower - before ultimately making a move lower, prompting our Alert to Lock.  The Bond market reaction looked to be a "sell on the news" response as well as not liking the stretched out time frame of the purchases.

Never remaining quiet for long, outspoken Kansas City Fed President Thomas Hoenig was the lone dissenter to the Policy Statement, commenting that he believes "the risks of additional securities purchases outweigh the benefits."  He is further concerned about "the risks of future financial imbalances" and "an increase in long-term inflation expectations that could destabilize the economy”.

This morning, Bond prices are starting the day sharply higher - and let's break down why.  Based on the Fed's announcement, it appears that the Fed will be buying all the 10-Year Treasury Notes coming to auction over the next eight months.  And while we know that mortgage rates are based on Mortgage Bonds and NOT the 10-Year Treasury - there is a piece of the relationship between the two that is important to understand.  If you are an investor looking to buy long term securities, you'll likely look at both the 10-Year Note, as well as Mortgage Bonds, or Mortgage Backed Securities.  If prices on the 10-Year Note rise like we are seeing today, investors will naturally start considering buying Mortgage Backed Securities instead…thus causing prices of Mortgage Bonds to move higher as well, via the higher demand for them.  But many experts believe this pop in the Bond market could very well be short lived and will be followed by even more volatility.

To that point, there are other concerns we must be aware of - like further devaluation of the US Dollar and rising Stock prices.  The US Dollar closed down just modestly yesterday, but it is getting killed this morning.  And as we've been sharing with you, this is exactly what the Fed wanted to see happen.  The weak US Dollar is helping Stocks trade sharply higher, as the weakened Dollar makes US exports stronger - via our goods and services costing "less" to foreign investors.  This is not only good for businesses, but consumers also feel more confident when the Stock market moves higher, and may be more inclined to spend, thereby helping to boost GDP.   

There is a old market saying - "Don't fight the Fed."  And this can be a great phrase to use when talking with clients and referral partners in the wake of the Fed announcement.  Yes, while Bonds are getting a government backed boost this morning…we need to be mindful that the Fed started QE2 for three reasons.  One, to spur spending which will create inflation; two, to help lower the unemployment rate via an economic boost; and three, to help push Stock prices higher.  And all three of these factors will cause headwinds for Bonds and home loan rates down the road.

In economic news today, Initial Jobless Claims in the latest week were 457,000 and above the 445,000 that was expected.  Continuing Claims fell 42,000 to 4.34M.   Additionally, there were 3.98M people claiming Emergency Unemployment Compensation (EUC) benefits, an increase of 199,000 from the prior week.  Not a great report and a reminder that Claims have been stuck to that 450,000 number like a magnet for a very long time.

Jobs Report Strategy

The Jobs Report almost seems anticlimactic after the week's historic events - but it is still very important, as maintaining full employment is part of the Fed's mandate.  Additionally, the Fed in their Statement yesterday said " The Committee will regularly review the pace of its securities purchases and the overall size of the asset purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment"  And some of that incoming information will be the Jobs Report each month.

Market expectations are currently for 60,000 jobs to be created, with the net gains coming from private sector growth, meaning that government job creation will be something close to nil.  Based on the recent ADP data and the modest improvement in Weekly Jobless Claims, we feel that the headline number will meet or potentially be a little higher than the 60,000 expected.

We also see that the Unemployment Rate could actually move higher to 9.7% from the present 9.6%, as more people fall off the extended unemployment benefits.  When they fall off the EUC benefit and re-enter the workforce seeking employment, they are once again "counted" as being unemployed, in terms of how the Unemployment Rate is tallied.

Although no one really knows what the report will unveil tomorrow - we feel a cautious and conservative bias towards locking and capturing today's improved price sheet is a prudent approach...particularly because most of your pipeline should be protected after the recent string of alerts.