Markets Await Directional Guidance from Fed Chairman

By: • Thu, Aug 26 2010, 10:48 AM

Following better than expected jobless claims data, rate sheet influential Treasury yields are inching out of overbought territory and stocks are cautiously testing the topside of their recent range.

The 2.625% coupon bearing 10-year Treasury note is currently +0-02 at 100-26 yielding 2.534%. Overhead support is first found at a long standing pivot: 2.548%. If that level is broken the next level of support lies at 2.58%.

2.548% is the lower limit of the "PANIC ZONE" on the daily chart we've had our eyes on.

On a relative basis, mortgages are trading better vs. rising Treasury yields (nominal), but flows are thin and MBS investors are hesitant about chasing basis tightening rallies, at least until benchmarks confirm a clear cut bias to fade the flattener.

The October FNCL 4.0 is +0-04 at 102-21 and the October FNCL 4.5 is +0-05 at 104-11. Production coupons are tighter vs. TSYs and swaps. UIC is the big winner again. Rate sheet influential MBS prices are consolidating around 102-16. If this level is broken the move lower could be large. (stored energy "explodes into the universe". Name that movie)

If you've been reading along over the past week you know I've been calling for the recent interest rate rally to reverse course. Poor housing data prevented that retracement from occurring in the first half of the week, but yesterday the rally proved to be getting a bit silly when 10s flirted with 2.40%. This was obvious via the aggressive manner in which 2.40% was rejected by the market. Yields have since risen back above 2.50%. While benchmark interest rates are experiencing a modest amount of weakness this morning, yesterday's yield high as yet to be broken and no major sell off has materialized. It seems we've come to a point where the bond market needs more directional guidance. Now what...

After the 7-year note auction today, the market's attention will turn to Jackson Hole, Wyoming where Ben Bernanke will deliver his economic outlook tomorrow morning at 10am. Some market participants anticipate the Fed Chairman will hint at the potential for further Quantitative Easing to restore investor confidence, others feel a move like this would only "spook the market". While I do believe Ben will spend a paragraph or two explaining the Fed's recent decision to buy Treasuries, I do not think he will explicitly mention any new QE programs (CMBS, Non-Agency MBS, Corporates). I do however feel the market needs a confidence boost though, economic data has not been investor friendly in anyway lately. Uncertainty is abundant and it's keeping capital in risk averse assets (principal protection).

I'd expect Ben to gently repeat that we need to get comfortable with the notion of a long, slow economic recovery. He should also remind us to expect periods of volatility. In the end I can only hope he provokes some sort of positive feelings with rhetoric indicating the world is not coming to an end. Whether or not this will be enough to spark a stock market rally I do not know. What I do know is summer is just about over and the investing environment has been downright boring lately. Bonds are way overbought, stocks have been surprisingly resilient to weak economic data, 3.5 MBS are not trading in size and mortgage rates have found a bottom at 4.25%. It seems like the market is craving a change of pace. Perhaps the timing of my "rates higher" outlook was off, but I still feel it's coming. Either way rates will be low for "an extended period".