The reaction to yesterday’s FOMC statement and Bernanke’s press conference was swift; US treasuries that were looking weak rallied taking the 120 yr note to 2.00% -6 bp yesterday on the close, but at 1.92% on the initial reaction. MBS prices spiked initially then backed off but still a very nice close, +16/32 (.50 bp). This morning treasuries are better as are MBS prices; at 9:00 the 10 yr note at 1.98% -2 bp and MBS prices +8/32 (.25 bp). US stock indexes at 9:00, DJIA +65; all major equity markets in Europe rallying on the Fed’s rate surprise. At 9:30 the DJIA opened +44, the 10 yr +12/32 to 1.96% -4 bp and MBSs +10/32 (.31 bp).

At 8:30 weekly jobless claims were in line with forecasts, +21K to 377K; continuing claims +88K to 3.554 mil. Dec durable goods orders were much stronger than estimates, expectations were for an increase of 2.2%, as reported up 3.0%. The more significant ex transportation orders were expected up 0.7%, as reported up 2.1%. Nov orders were revised higher, frm 3.8% to +4.3%, ex transportation frm 0.3% to +05%. The two reports added a little more strength to the stock indexes in the futures markets.

More data at 10:00; Dec new home sales were expected to increase 1.5% to 320K annualized units, as released sales declined 2.2% to 307K; based on sales there is a 6.1 month supply, for all of 2011 sales were down 6.2%. Dec leading economic indicators were expected to be up 0.7%, as reported +0.4%, Nov revised to +0.2% frm +0.5%. No immediate reaction to the data.

This afternoon at 1:00 Treasury will complete its auctions with $29B of 7 yr notes; yesterday’ 5 yr auction met with solid demand.

The slightly bearish bias in the bond and MBS markets turned quickly yesterday on the Fed’s announcement. Prior to the Fed we were thinking the 10 yr would climb to 2.15% but go no further, the highest it got was 2.09% on Tuesday. Now the obvious question we are tackling is, how low will the 10 yr yield go based primarily on the Fed holding the FF rate at current lows until the end of 2014; and how low will mortgage rates go now? It is unlikely US interest rates will decline to new lows, at this point we expect the wider trading range will continue with the possible low on the 10 at 1.80% and mortgage rates tied to a 25 basis point range in rates. The Fed is worried about the US recovery and that Europe will continue to decline with eventual debt defaults in Greece and other EU countries. Until there is another Europe shock it is unlikely that US rates will push to new low rates. It will take a few days for traders and investors to assess the message sent yesterday from the Fed when the Committee made such an unusual move.

No changes or improvements over Europe’s debt mess. Greece is on the front burner now; on Monday there was widespread belief the Greece and its creditors would make a deal and avoid defaults. Yesterday the optimism waned as private investors (banks) refused to take the losses necessary to save the country. Today the ECB said it would not participate in any writedowns on the Greek bonds it holds, saying the central bank isn’t an investor, it bought the debt to aid Greece in an attempt to avoid default. Summing; nothing is being accomplished with Greece. International Monetary Fund Managing Director Christine Lagarde said today that European governments and other public holders of Greek debt may have to increase support if private creditors don’t go far enough. Investors and European finance ministers remain at odds over how much private investors should shoulder in the Greek bailout.

The US bond and equity markets have largely become desensitized about momentary events and comments out of Europe. There is a slowly increasing belief in US markets that eventually Europe will save itself and its currency; likely driven by the view that anything short of some acceptable plan would be a catastrophe to Europe and rest of the global economies. Safety moves into US treasuries have ebbed, at the moment there is little motivation to move into treasuries, yet so far there is not much reason the dump fixed rate treasuries. The 10 yr note yield has increased from 1.85% on 1/13 to 2.06% yesterday, mostly traders reducing exposure; MBSs also have increased in rate. Although rates have increased some as we noted they would, at the same time we do not expect interest rates to move much higher; our target for the bellwether 10 yr note is 2.15% and no higher, worse case for mortgage rates, another 10 basis points in rates on 30s.

Working against the bond market, less concern over Europe and improved US economic outlook. Most all key economic reports in the past three months have beaten estimates. On Friday Commerce will release the advance Q4 GDP, consensus is+3.1%, up frm +1.8% in Q3. While the fed will continue to keep short rates low as it has said repeatedly, the long end of the curve (10 yr) has seen its lows. There is an idea out there that the Fed may decide to increase its purchases on MBSs in an attempt to keep mortgage rates low, but if treasuries increase about all that can be expected is the yield spread between MBSs and treasuries will narrow. It is not likely that treasury rates would increase while mortgage rates fall.

At 10:00a few minutes ago; Dec pending home sales (contracts signed but not closed) was expected down 1.0%, sales fell 3.5% with about a third of sales are not going to the closing table; yr/yr pending sales up 5.6%. Nov FHFA housing price index expected -0.1%, jumped 1.0%; yr/yr -1.8%. There was no market reaction to the two housing reports.

US rate markets will likely stay quiet through the morning and early afternoon ahead of the FOMC statement and Bernanke’s press conference this afternoon. At 9:30 the DJIA opened -45, the 10 yr unch and mortgage prices also unchanged to slightly lower.

There are no economic releases this week until Wednesday. The week is focused on the FOMC meeting that starts tomorrow and ends Wednesday with the policy statement. Treasury will auction its monthly ration of $99B in 2 yr, 5 yr and 7 yr notes. The Eurozone of course is always in play these days, any significant comments from leaders of the EU, ECB and IMF will get traders’ attention. Technically, the bond and mortgage markets, after last week’s selling, are now slightly bearish. We talked about how the rate markets were losing momentum for the past two weeks, the break came last week.

How high will interest rates climb is the question now facing investors and traders. We don’t believe rates will increase much, at worst the 10 yr could increase to 2.15% but should hold. On the opposite side, it is very likely that the lows in rates have been put in place. As long as the US economic outlook is imp[roving, and there are no actual defaults in any Euro debt there is little reason to justify the 10 yr under 2.00% and mortgage rates at their lows of a few weeks ago.

Europe’s finance ministers are meeting today in Brussels, trying to advance plans to craft a long-term plan to tackle the region’s debt crisis, as banking and government negotiators continue trying to reach an agreement that will lighten Greece’s debt burden. There has been progress over the past couple of weeks, Greece and private bondholders said they had made progress in talks over the weekend in Athens. Finance Minister Evangelos Venizelos said before today’s meeting that Greece is prepared to wrap up the private-sector debt swap on schedule. “We have a very constructive cooperation with the private sector,” Venizelos told reporters in Brussels. “We are ready to finalize the procedure on time.”

This Week’s Economic calendar:

       Tuesday;

1:00 pm $35b 2 yr note auction

Wednesday;

7:00 am MBA mortgage applications

10:00 am Dec pending home sales (-1.0%)

Nov FHFA housing price index (-0.1%)

1:00 pm $35B 5 yr note auction

2:15 pm FOMC policy statement

Thursday;

8:30 am weekly jobless claims (+23K back to 375K)

Dec durable goods orders (+2.2%, ex auto sales +0.7%)

10:00 am Dec new home sales (+1.5% to 320K units (annualized)

Dec leading economic indicators (+0.7%)

1:00 pm $29B 7 yr not auction

     Friday;

8:30 am Q4 advance GDP (+3.1%)

9:55 am U. of Michigan consumer sentiment index (74.2 frm 74.0)

The bond and mortgage markets have been losing strength for two weeks as we have indicated in past commentaries. The 10 yr note won’t find much support until it hits 2.15%, now at 2.09%; not much momentary concerns to hold treasuries against Europe. US economic outlook is improving, removing another support for rates. There is some talk that the Fed may announce it will increase purchases of MBSs to keep mortgage rates low, but as long as treasury rates increase the best we can expect is mortgage rates won’t increase as much but will increase. All that said, while we do not expect rates will fall again to the recent lows we are equally not expecting rates to move radically higher.

The FOMC meeting won’t likely have any new policy implications; the Fed will continue to keep the FF rate at 0.0% to 0.25% as Bernanke indicated months ago. We are not looking for another QE from the Fed; Europe for the moment has stabilized somewhat and the US economy is likely to have grown 3.1% in Q4. Europe’s impact on US markets has lessened recently with Italy and Spain able to auction debt at better rates than two months ago. The debt problems however, are far from being over, it will continue to be a factor throughout this year and at times roil US markets. We are looking for flat markets early this week.

©Mortgage Commentary 2012

This week a few key economic reports that will get traders’ attention; PPI, CPI, Philly Fed business index, Housing starts and permits as well as Dec existing home sales and weekly jobless claims all on tap (see economic calendar). US interest rate markets continue to hold well, at the same time the long end including mortgages is struggling to keep a positive bias. Europe’s travails and this week’s economic data should define whether rates will move lower. That said, with rate increases due to Congress using Fannie, Freddie and FHA to finance the social security tax cut, mortgage rates are not likely to fall much more even if US treasury markets improve somewhat. We remain skeptical on the longer term outlook for rates, rates are likely to increase a little this year with the economy improving. The wild card now is the Fed (Europe is always a wild card on a day-to-day basis); last week there were some that were floating the idea of another easing move from the Fed, still a minority view however. On the 24^th and 25^th the FOMC meets, likely there will be discussions on the subject.

The U.S. import bill was driven by demand for higher-priced crude oil at the same time American companies tempered orders for consumer goods on concern household spending will cool early this year. Exports from the U.S. declined to a four-month low, depressed by a drop in shipments to Europe. The U.S. trade deficit widened more than forecast in November as American exports declined and companies stepped up imports of crude oil and automobiles. The gap expanded 10.4 percent to $47.8 billion, the widest since June, from a $43.3 billion shortfall in October, Commerce Department figures showed today in Washington. The deficit was larger than any of the estimates.

At 9:00 30 yr MBSs were +6/32 (.18 bp), stock indexes pointing to a weaker open. At 9:30 the DJIA opened -100, the 10 yr note +17/32 at 1.86% and mortgage prices +7/32 (.22 bp) on 30s and +4/32 (.12 bp) on 15s.

About 9:00 this morning some of the wires were reporting S&P is about to lower the credit rating for countries in Europe. While not unexpected, if the reports are true the downgrades are coming sooner than what many were expecting. The news added additional pressure to stock indexes already weaker.

At 9:55 the U. of Michigan consumer sentiment index was expected at 71.5 frm 69.9 at the end of Dec; the index jumped to 74.0; current conditions increased to 82.6 frm 79.6, expectations increased to 68.4 frm 63.6, and the 12 month out index increased to 79.0 frm 70.0. It is the mid-month survey and although stronger than expected there has been no reaction to the report.

Trade today will likely be more defensive with markets closed on Monday for MLK. Generally a three day weekend with other global economies open increases safety, likely the bond and mortgage markets will hold strong with investors and traders increasing long positions. US equity markets will be under pressure, also due to the long weekend.

The improvement in the 10 yr note this morning, breaking below 1.90% increases the bullish technical bias somewhat. Until this morning the bond market, while bullish was losing momentum, that it pushed below 1.90% projects a possible test of the recent low at 1.80% achieved on Dec 19^th. There is always a caveat however, the strength today may be somewhat exaggerated due to the long weekend. In the mortgage world, be careful with your lenders as they begin to add in the increases in rates that Congress dictated to the agencies to finance the 2.0% social security cut extension. Many lenders have put on time tables, others it’s a crap shoot as to what day the hammer will fall. Even with treasuries doing well, mortgage interest rates will increase with the increased G fees mandated.

At 9:30 the DJIA opened +15, the 10 yr note slipped to -1/32 at 1.91% unch and MBS prices unchanged. The US markets are ignoring the weak retail sales and increase in unemployment claims in favor of the constant and inconsistent news out of Europe. Yesterday there were reports that Germany’s economic outlook was worsening with manufacturing slowing, talk that Europe would fall back into recession. This morning European Central Bank President Mario Draghi said there are some signs the euro-area economy is stabilizing even as the sovereign debt crisis poses risks to the outlook. “According to some recent survey indicators, there are tentative signs of stabilization of economic activity at low levels,” Draghi said at a press conference in Frankfurt today after the ECB kept its benchmark interest rate at 1 percent following two straight reductions. “The economic outlook remains subject to high uncertainty and substantial downside risks,” he added.

Spain and Italy successfully sold notes this morning. Spain auctioned 9.98 billion euros ($12.7 billion) of bonds maturing in 2015 and 2016, including a new three-year benchmark security, twice the maximum target of 5 billion euros set for the sale. The yield on the three-year notes was 3.384 percent, compared with 5.187 percent when the nation sold similar notes in December. Italy sold 12 billion euros of Treasury bills, meeting its target, and its borrowing costs plunged. The Rome-based Treasury sold 8.5 billion euros one-year bills at a rate of 2.735 percent, down from 5.952 percent at the last auction. The auctions were stronger than expected providing a razor thin idea that Europe’s debt issues may be waning; an idea completely wrong, Europe is headed for default and in our view another recession, the second in the last three years. That said, there isn’t any strong conviction regardless of ones outlook for Europe.

At 10:00, Nov business inventories, expected up 0.4%, were up 0.3%; sales up 0.3%; the inventory to sales ratio unchanged from Oct at 1.27 months. No reaction to the report.

Next up today; at 1:00 Treasury will auction $13B of 30 yr bonds, re-opening the 30 yr issued in Nov. The 10 yesterday and the 3 yr auction Tuesday saw good demand, likely the 30 yr will also.

At 2:00 Treasury will report the Dec deficit expected -$79.0B.

Will interest rates continue to fall? Hard to handicap the outlook given the mess in Europe; so far the technical are holding but losing a lot of momentum with investors and to some extent with traders. On recent rallies the 10yr has not declined to its previous lows, on selling it hasn’t increased more than previous selling bouts. A coiling spring with the trading range narrowing each day suggests a breakout is coming, the direction yet to be determined. The outlook for the US economy is being ratcheted up, there hasn’t been any new shocks out of Europe’s banking and credit crisis, keeping the bond and mortgage markets in narrow ranges. Safety trades into treasuries is waning, however traders and investors are reluctant to sell US treasuries.

©Mortgage Commentary 2012