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Thursday, August 18, 2016

Mortgage Bond Market Analysis - Some History and Some Prognosticating

It's Jobless Claims Thursday and all the data came in about as expected.  Before I get to the data, I want to talk a bit about recent history and share some thoughts on the not-to-distant future.  In 2015 the Fed ended the Quantitative Easing program where they were purchasing $40-45 BILLION in MBS (mortgage-backed securities) every month.  The law of supply and demand had many experts believing, including myself, that rates would go up since it was inconceivable that all of that buying could be replaced by the world's investors.  The buying that the Fed was doing was helping to keep mortgage bond prices propped up which kept rates low - rates / bond yields move inversely to price, i.e. as prices go up, rates go down.  What we didn't know then is that the rest of the world's economies were so bad and the yields offered on those economies' debt was so low that more investors started channeling money into US debt offerings, including our mortgage backed securities.  While the yields aren't very high, they are higher than about all other 1st world debt and mortgage bonds are considered a safe investment.  Because of this, rates have stayed at or near the levels when the Fed was buying MBS.

Throughout 2015, the Fed hawks grew stronger in their belief that the Fed should begin raising the Fed Funds rate.  They were able to convince enough fellow Fed voting members to raise the rate .25% in December.  Stock market investors immediately reacted with a major sell-off that resulted in a loss of an estimated $3 trillion in wealth to ma and pa investors.  Since then we have seen a lot of mixed data with lots of weakness in the manufacturing sector.  There have also been a few months with weak jobs data and several others that have shown very marginal growth.  The trend in 2016 has shown an economy on the mend, albeit a very slow healing process.  The jobs numbers aren't anywhere close to where they need to be, especially if you look at the labor force participation rate which is still hovering around a 39 year low.  Manufacturing has picked up and has shown more consistent positive numbers.  The non-manufacturing sector (aka service sector) which makes up about 70% of our economy has been very strong.  Inflation isn't a threat - yet - and consumer confidence and spending are not always in line with each other with spending still on the weaker side than it should be for a strong recovery.  What this means is that the Fed has not raised rates since their move last December and while many thought that September would be the next time that it happens, the market is saying otherwise.  I think the Fed is afraid of what might happen in the equities markets if they do raise them and the economic recover really isn't in full swing - they are afraid of another December / January meltdown like what we had eight months ago.  Will they raise rates by the end of the year?  That's anybody's guess but it may depend on who's elected president and the market's thoughts on how the next president will do with the economy.  It will certainly depend on actual results in the data.

For now, the price for the FNMA benchmark bond remains in a tight range and is just 40 basis points below the closing price of July 29th.  That's not a lot of movement and there's not much to suggest a big move one way or the other.  Trading right now is more about short-term profits and trying to be on the right side of the economic data.  Jobs week always has the potential for some big moves since lots of important data is released AND if the jobs data shows much stronger than expected, traders could sell off in a big way.  The first week of September is the next jobs week so until then, I don't anticipate a strong influence on the bond market other than the annual Fed retreat to Jackson Hole, WY.  Fed Chair Janet Yellen will give her opening remarks for the summit tomorrow and, as usual, bond traders will be hanging on every word.  There's a good chance she won't provide any definitive information - probably because they don't have any.  For now the RSI is at the mid-point between overbought and oversold so that's a non-factor.  The current bond price is right around the 25 day moving average and at 103.68, it is one basis point below the 2nd level of resistance.  Initial jobless claims came in slightly better than expected while continuing claims came in slightly worse.  The Philly Fed Manufacturing Index came in exactly as expected.  I would lock if you or a client has a loan in a stage where it can be locked.  I don't see enough upside potential to float.  Going forward, my guess is that rates will remain low for probably a good while.  Make it a great day.

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