Market Update – April 6, 2010

As expected, rates this year have moved up. Did anyone think that they weren’t? In a cocktail party discussion, it is a quick and easy statement to make: “Well, the economy is doing well, which can be somewhat inflationary and lead to higher rates, and our government keeps auctioning off more debt to finance our spending deficit.” Of course you can go into the details about higher oil and gold prices, the stock market rally, etc. if you like. The yield on the 10-yr hit its highest level since the summer of 2008, and the job numbers are showing some strength. And we all know that the government plans on hiring more census workers in the coming months.

But the economy is still too weak to handle high rates. As Paul Jacob from the Banc of Manhattan noted, this expansion may be different from the last expansion, “which was marked by relatively low rates, low volatility, low inflation and low spreads.” This time around the US deficit situation is much worse, adding supply pressures & some long-term inflation fears, and the economy is worse, with negligible current inflation.

All rates have been going up, but what have spreads between MBS’s and Treasuries been doing since April 1? Fortunately for originators, spreads haven’t done much, and in some cases actually improved. So even though all rates have been going up, mortgage rates, even without the Fed, have not done much on a relative basis – it seems that bank and money manager demand as picked up. It helps, in a convoluted way, that mortgage origination appears to be down, which tends to work in our favor for mortgage rates. No one wants to catch a falling knife, but there is plenty of cash out there waiting to be put to work in buying securities.

Yesterday we had the Pending Home Sales Index, a forward-looking indicator based on contracts signed in February, go up 8.2% in February. This measure stands about 17% above where it was a year ago. This data measures contracts signed, not closings, and a lot can happen in the month or two it takes to process a loan. As mentioned, the 10-year note traded through the psychological 4.00% level, although the market liked the strong 10-yr TIPS (Treasury Inflation Protected Security) auction coming at 1.709%, 4bps through the 1PM levels, a record 3.43 bid to cover. Today, however, is another day, and we have $40 billion in 3-year securities to buy. (Tomorrow we have $21 billion in 10’s, and on Thursday $13 billion 30-yr bonds.) And we are seeing a bounce this morning: the 10-yr is down to 3.95% and mortgage prices are better between .250-.50.