Monday 6/30/08 ....... Still Steady, Chicago PMI mixed

By: Matthew Graham •
The Numbers:

 6.0% FNMA is up 4 / 32nds at 100-30

5.5% FNMA is up 7/32nds at 98-21

 
The News:

  •     Chicago PMI at 49.6
    • Consensus was for 48.0
    • 5th straight month under 50.0 (under 50 = contracting business conditions)
    • Cost of goods sold paradoxically decreases 2 pts to 85.5, speaks to inflation
  • Citi Bonus restructuring
    • CitiGroup, hammered by bad press last week, announced it would restructure management bonuses
    • The move ostensibly should increase performance, but has not done anything for their stock price
    • The market will "believe it when it sees it"
  • Analysts coming off the sidelines
    • A majority of analysts are predicting further stock declines, but some ardently say we are at a bottom
  • Oil
    • continues near record highs pressuring stocks.
Conclusion:
So far another stagnant or down day for stocks is another positive--albeit slightly--day for MBS.  Earlier in the morning, MBS were outperforming treasuries on the day, but have sense joined at dead even from Friday's spreads.  As the markets continue to fear further stock declines, bonds continue to be strong.  With the Chicago PMI being the only substantive scheduled release of the day, our potential direction for the rest of the day will likely come courtesy of stock market movements.  The negative predisposition towards MBS that began to emerge last week seems to be waning as all eyes turned towards the bear market.  So far this week, that sentiment holds.

Lock or Float:

Floating into this afternoon continues to make sense as long as stocks do not rally.  As opposed to having to constantly refresh this page today, you should be able to get a fair indication of impending volatility from stock averages and the 5 year note (remember the 5 year is the flavor of the month as far as UST's are concerned as the current coupon in MBS, the 6.0, has roughly a 5 year speed right now).  We have pushed into good territory as of Friday afternoon, but again, lenders have not passed that on to us yet.  This is usually the case: lenders price more spread into their rate sheets when MBS are rising from weakness.  That spread will decrease the longer we can hold these levels and also with decreased volatility.  Still, you should see improvements over Friday.
 
One reason to consider taking those gains and moving on is the rebound factor.  We almost never see any price, quote, or average string together over a week of consistent directional movement without reversing course even if only for a day.  With MBS working on a decent winning streak at the moment, the likelihood that stocks will gain and MBS will worsen, even if only for a day, gets higher and higher.  It should be of some concern that stocks are as low as they are.  Granted, more analysts than not think that continued weakness is in store, but don't count out this market's propensity to "latch on" to any positive data in times of decline.  This means that if equities get a a reason to rally, the effects may be disproportionate to the catalyst.  This could artificially damage MBS.
 
Fed Funds futures will play a bigger role this month than most as we are at that critical stage when we will either stay at 2.0% or move up.  Futures currently indicate a 60% probability of holding steady.  If this were to shift to 2.25, the strength of MBS versus treasuries would be test, and only if MBS were significantly preferred could we hold on to current rates.  On the other side of that coin however is inflation.  Depending on how much inflation risk is priced into bonds at the moment, a .25 raise in Fed Funds will certainly not have a .25 impact on MBS as that will go a certain way to ease inflation concerns.  
 
Good news to close today: even as stocks have moved into positive territory on the day, bonds are not yet convinced.  Again, keep an eye out for a bigger DJIA rally and also the movement of the 5year note.