1/7/2009

The mortgage markets were the runaway winners today as mortgage rates for 30 yr fixed conforming loans in some areas hit 4.875% with a point origination. The mortgage markets continue to see interest in MBSs now that the Fed has actually started buying them. That said, the mortgage markets are still not functioning well and wholesalers are trying to control the flow by worsening prices at times when there is no direct market reason for it. How much lower will rates fall? We have been reluctant to jump on the 4.5% bandwagon that many are still waiting for, but with the Fed in the game, if it wants to it can get rates to that level and maybe lower. Right now, just buying $500B in MBSs from the agencies isn't enough to get to that 4.5% level. Furthermore, if treasury yields increase investors will go there if the spread between the 30 yr MBSs and the 10 yr note begins to narrow too much---what that level would be is impossible to speculate now.

The FOMC minutes from the Dec 16th meeting were released this afternoon. The most noticeable in the minutes; the Fed's concerns that inflation levels might fall below what the Fed needs to support the economic growth and price stability. We have brought it up a few times in the past months, a little inflation is a good thing, while deflation is as damaging to the economy as too much inflation. "Participants agreed that falling prices for energy and other commodities and diminished economic activity had resulted in an appreciable reduction in inflationary pressures. Those pressures were seen as likely to continue to abate because of the emergence of substantial slack in resource utilization and diminishing pricing power"...." Several participants observed that monitoring measures of inflation expectations for signs of disinflationary dynamics would be especially important going forward". The Fed wants inflation at 1.0%; without some inflation there is little motivation for consumers or businesses to spend which is what the economy needs now.

After strong selling through most of the session in the treasury markets, by mid-afternoon the treasury markets crawled back to unchanged. The 10 yr yield jumped to 2.57% this morning but will likely continue to hold its key technical support at 2.50% on a close later today.

Today's $8B 10 yr inflation indexed auction went well giving a slight lift to treasuries. Tomorrow Treasury will sell $30B of 3 yr notes and Thursday $16b of 10 yr notes on the re-open of the current 10 yr. Supply will continue to provide pressure for the long end of the curve. In the FOMC minutes released this afternoon the there was discussion about the Fed stepping up to buy treasuries to assist in keeping rates low.

Tomorrow the ADP employment guess for Dec and the $30B 3 yr note auction are the only headliners we know of.

Chase pulled the plug this afternoon, shutting down accepting rate locks by worsening their prices by 16/32; no reason we saw, the mortgage markets themselves are at their best levels of the day. One serious problem confronting the originations and re-finances is the lack of lenders. Many wholesalers are gone and those that are left cannot handle the volume such as we saw today. Chase should set limits for how many locks and not screw originators as they did today. One more graphic example of what the credit market shut down can do.