Greetings from Madrid, Spain. In the last week, I have flown from Las Vegas to Miami, FL, down to Santiago, Chile and back and now I sit in Madrid. Doing this much travel makes one wonder where am I and where am I going? The good news for my travels is that I always have to return to Miami. Mortgage backed securities, on the other hand, do not have to return to anything.
Last week saw mortgage bonds in another spiral downward, as I expected. Fueled by inflationary fears created by the Fed themselves with all of their talk and likelihood of no action. The Fed’s division seems to be growing as some, like Plosser, say the Fed needs to do something, while others, like Bernanke, feel there is no hurry to raise rates.
As economic data came in, it showed a continued trend. Retail Sales beat expectations, showing an economy that is not as bad as portrayed. Even Pending Home Sales beat expectations, though a “housing bottom” remains to be clearly seen.
Of course, the real question of last week was does the data support inflation fears. The CPI data showed it does, but the media and others focused on inflation at the core level instead. Since food and energy prices are volatile, many feel that the core level is the better gauge of inflation and that was 2.3% for the last year. Reality is that food and energy prices are still factors that have not yet been “spread” through and with no drop in prices in sight, those costs will have to be spread. You can see that in the airlines as they scramble to pass on costs. Overall inflation came in at 4.2%.
Greenspan, as usual, didn’t help things either. His commentary this week included statements that the worst of the credit crisis is over. By the end of the week, bonds had moved over 150 basis points lower and mortgage rates rose to their worst in about four months.
Where do bonds go from here? This week is likely not going to change things. Bonds may get a bit of a correction (stochastics show a need), but the overall trend will likely be unbroken. The big event of the week will be the Philadelphia Fed Index, but the PPI and other reports could shake the markets a bit as well. Here is the scheduled programming…
- Monday: Empire State Index (8:30)
- Tuesday: Producer Price Index (PPI) (8:30), Building Permits (8:30), Housing Starts (8:30), Industrial Production (9:15), Capacity Utilization (9:15)
- Wednesday: Crude Inventories (10:30)
- Thursday: Initial Jobless Claims (8:30), Index of Leading Economic Indicators (LEI) (10:00), Philadelphia Fed Index (10:00)
As this week begins, I do not see a change in the overall trend. While bonds may get a correction rally, without sufficient reason, the indications are that the downtrend will continue, so I suggest locking. Keep in mind that the Fed will be speaking this week and their comments have an effect on the markets as well.
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{ 5 comments… read them below or add one }
Robert Novak, from the Chicago Sun Times, has an article where he says a ’source’ close to Bernanke told him that rates are not going to be raised. And oil’s been going down on reports of Saudi Arabia increasing production. So do these two cancel each other out, as far as bonds are concerned?
Hi Robert, I hope your taking some time to enjoy yourself on your travels. Good post as always it seems that “inflation expectations” is the story and the internal fed argument about it. I sent you an email did you get it?
Ling,
Bernanke can only control short term rates (fed funds). Market forces determine longer rates, IE the mortgage rate.Saudi Arabia increasing production theoretically brings down the cost of oil, therefore brings down inflation. however, the market does not trust the Saudi’s and therefore in the long term discounts what they say for oil price valuation.
http://www.itradebonds.com/blog
Ling - Not really. I fully expect the Fed to keep rates unchanged, though I want them to start raising them to fight inflation. Oil has too many factors to simply rely on Saudis increasing production as you probably already figured out.
With the Fed not raising rates, that is not very favorable to bonds as it allows inflation to entrench further. Oil prices dropping are but one aspect of inflation and we still have yet to see the recent run ups passed on down the chain, so inflation will likely still increase for a while even if oil and food dropped off.
Cliff - Inflation expectations is a key ingredient in the direction of mortgage bonds (and rates). The Fed claims to try to control it, yet they do nothing in actuality, so actual inflation will likely increase and greater expectations will get fueled further. As for the email, I received it and did respond (rather late, sorry). Hopefully you got that response.
Evangelist - Very interesting perspective to which I agree. I would only add that while the Fed does only control the Fed Funds Rate, their decisions indirectly affect mortgage rates (usually move opposite).
Yes I did get your email thanks. I agree Saudi’s have little affect at this point on inflaiton. Especially when you consider they are pumping “surplus.” Although supply and demand plays a role it appears oil markets supply and demand are playing an even bigger role.
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