Daily Report | 10 March 2010
Current Trend Direction: Sideways
Risks favor: Locking Bias
Current Price of FNMA 4.5% Bond: $100.78, -22bp
Reminder: Yesterday after the close of trading, Mortgage Bonds had their monthly coupon rollover. The effect of the rollover was -34bp points for the 4.5% coupon. Every month the coupon “rolls over”. When this happens, this month’s coupon is closed out and all new loans are placed into next month’s coupon. There is no effect on rate sheets or pricing. Additionally any candle chart patterns that arise from the rollover must be taken with a grain of salt.
Bonds are starting the day lower. With no economic reports set for release, the markets are looking ahead to the whopping $21B 10-Year Note auction results at 1pm ET. Yesterday’s 3-Year Note auction showed good results, so it will be interesting to see if the markets easily absorb the longer duration of the 10-Year Note paper today. The time frame of the Notes, 10 years, does carry more inflation risk.
Yesterday a $149B spending bill of tax breaks, unemployment aid and extended health benefits cleared a procedural hurdle and will now go to the House and Senate for passage, and then onto the President to be signed into law. The tax breaks are meant to spur small businesses into hiring. Unfortunately, we think this is not going to be very productive. Think about it if you are not going to hire an employee that costs $50K per year, would you really think that employee would suddenly be hired if your company were given a $2K tax break? Of course not. It appears that common business sense is lacking – and much worse yet is that those companies who would have hired an employee now get a windfall of this tax break. Bottom line – this is simply throwing money away, and creating absolutely zero incentive to actually hire. However, what this really is about is that every politician supporting this bill will take credit down the road for any new hires where this tax credit was issued.
There’s an old saying “There’s never only one cockroach”, and it could now perhaps be changed to “There’s never only one dissenter.” Right now the list of Fed Members dissenting against the language to keep rates low “for an extended period” is growing. Kansas City Fed President, Thomas “BBQ” Hoenig, first dissented at the Jan 27th Fed meeting and voted against the language to keep rates low “for an extended period”. Now the parade seems to be on, as in recent weeks, Dallas Fed President Richard “Loose Lips” Fisher, St. Louis Fed President James “Raging” Bullard, Philadelphia Fed President Charles “Three-Swing Charlie” Plosser and Chicago Fed President Charles “Chuckwagon” Evans have all expressed their concern about keeping rates low for too long. The main reason for their concern? Inflation.
Right now, the Fed has a tough job in deciding when to remove this accommodative language and when to actually hike rates. If the Fed hikes rates too soon we could see our fragile economy dip into another recession, thereby flushing all that stimulus plan money down the toilet. But if the Fed remains accommodative too long, ie: leaving rates too low for too long it could spark inflation. It is very likely that the Fed will err on the side of holding rates too low for too long, and will undoubtedly get some political pressure to do so, which would have a damaging effect on the economy via inflation if they are not careful. The complacent attitude we see from many on the threat of inflation does concern us. History has shown that inflation can build very quickly from very low levels.
We are going to keep our Locking stance as prices are now trading beneath both the 25 and 100-day Moving Averages. The next clear floor for prices is the 50-day Moving Average, another 12bp beneath current levels.
Keep your dreams big and your worries small.