Wednesday 6/18/08 .......... Predisposition Towards Locking Waning

By: Matthew Graham •
In A Word:

What's worse: inflation or  a despondent economic outlook?  Looks like the market's answer today is the latter.  After all the sturm and drang  about inflation last week and all of the fallout therefrom, we seem to be easing back into the operating  philosophy that the economy is SO BAD that traders can buy bonds despite inflation concerns.  MBS are improved and gloomy forecasts abound.  The Dow is approaching the 11k's for the first time in a long time, and maybe, just maybe, the weakness will be extreme enough, and the inflation fears will moderate enough for us to regain some more of the ground we've lost in the past two weeks.

The Why:

In a word (again): stocks.  Fed Ex released horrible earnings.  Is it really a big surprise that the the world's largest courier carries less packages when the economy has slowed?  Well, hindsight is 20/20, kind of like gun manufacturers and defense stocks rose sharply after 9/11.  This is the same reason smart folks went long on Wal-Mart when the economy started to weaken.  But enough stock psychology analysis.  Long story short, there is a balance of urgency between inflation and growth, with different FED mouthpieces professing that one side or the other is more important to our economic health (inflation hawks versus doves).  No matter how hawkish one might be, you can't ignore the continued recessionary trends.  Though it's an obviously delicate balance, wherein monetary policy decisions have far reaching impacts, and though, again, hindsight is 20/20 (in that we won't truly know what is more important in this particular economy until we look back at the results) the speculation that Uncle Ben will raise the benchmark rates is waning.

To Lock or Float?

As Big Ben's predisposition towards raising rates wanes, so too does our firm predisposition towards locking early and often.  I'm not saying there is a direct causality here, but rather, and analogousness.  In other words, the factors that are causing the Dow to drop, treasuries to rise in price, concern over growth to begin to compete with inflation, and ultimately the anticipated absence of a rate-hike, are the same factors that are allowing some traders to get on board with bonds today.  We are experiencing gains into the morning so our float/lock playbook calls for cautious floating.  We're tracking fairly well with treasuries and stocks this morning, so you can look for immediate cues from the 5 yr note (not the 10 year!  "Speeds" on MBS are around 6 years right now making the 5 year a significantly more germane benchmark). 

The Numbers:

 

6.0% FNMA OTR IMPROVED by 9/32nds

6.5% FNMA OTR is better by 5/32nds

Here's a Graph of yesterday and this morning's price action.  Not much of a jump overnight, but we got a little bit nonetheless.  At least as many gains have come from the trading day so far which is always a good thing.  After all the disharmony, lender will probably be pricing a bit conservatively, so if you have an itchy trigger finger, try to hold out for a bit.  Even if we can just maintain this 9/32nds improvement, we may get additional reprices.


 

The News:

  • Stocks
    • Though not a scheduled economic release which is what this section is normally reserved for, it's a market mover today nonetheless.
    • Fed Ex, on bad earnings, is down
    • Morgan Stanley, same
    • Fifth Third, same (well, not earnings, but they did cut their dividend, forecasting bad earnings)
    • RBS warns of steep sell-off in stocks.  Reminds me of that song: "Oh wouldn't it be wonderful."
  • Purchase Applications
    • Surprise, surprise, they are down sharply.
    • Refi applications lowest since July 06 (rates were high, remember)
    • But this is not a major impacter of rates, and the only news outlet that cares seems to be CNBC.
  • Petroleum Status Report
    • Crude inventories down only 1.2 mln barrels, less than expected
    • What?!  People don't want to pay 4.70 per gallon for the premium that their supercharged V8's require? (it was an emotional decision, and I learned from it!)
    • This may give us an ever so slight lift as more plentiful gas is a precursor for inflation lion-tamers to take center stage.
  • That's it as far as scheduled news on the day!  Tomorrow is action packed, and Friday is quadruple witching, and a spicy smattering of volatility is almost always in that witch's brew.

Conclusion:

The vacation from the carnage continues!  MBS are outperforming treasuries.  The reason is usually twofold: a) with low treasury rates combined with high inflation, investors have to look elsewhere to eek out a return, b) dearth of apocalyptic mortgage news (yeah, come to think about it, the sky hasn't been purported to be falling on the mortgage industry for quite some time now).  So we are gradually seeing a tightening of MBS to the yield curve.  The great news there is that it got so blown out, gapped out, as they say in the inner MBS circles, that there is plenty of room left to improve.  So even in the face of inflation, MBS are donning better armor than UST's.  If the fear of economic woe persists, and indeed the woe itself continues to stay at the party, it is yet another box of high caliber ammunition with which MBS can fight their way to victory.  So although it means the suffering of your people on a larger scale, the sad state of the economy is your best friend.  My, my, mortgage brokers are a sadistic lot! 

But all joking aside, and to reiterate, inflation concerns took center stage last week.  Now it's the week economy.  If the economic indicators of inflation remain less than awful, and the economy remains more than awful, we could be right back in the game sooner than anticipated.  Don't hold your breath for this because we could go either way, and in a hurry.  Be wary that psychologically, the Dow index seems to be very panicky about being at the 12k level.  So just as it was the last time we approached this territory, expect traders to wildly cling to any and all impetuses to buy equities right now.  This could spoil our MBS party for sure, but for now, we are off to a good start, and can only hope the dow holds its 100 point loss today, and that the Federal Mints don't set up lemonade stands outside their buildings and start hawking dollar bills for "tree fiddy."