Bond Market and Rates

After yesterday’s slide for Mortgage Bonds, which was driven by the rally in Stocks, we are seeing a bit of a reversal this morning – again driven by the action in Stocks, where a battle between the Bulls and Bears over the important 200-day Moving Average is being waged. Yesterday, both the Dow and the S&P500 indices were able to climb above their respective 200-day Moving Averages. Both Bulls and Bears know what an important line in the sand this level is…and the Bears aren’t relenting just yet. The Bears attempted to push Stocks back beneath the 200-day MA early in today’s trading session. This helped Mortgage Bonds achieve their highs around the same time. But then – the Stock Bulls mustered enough momentum to bring prices back above this important level, reducing both the losses in Stocks and gains in Bonds.


And this is where we are currently trading. We’ll keep an eye on this important battle throughout the day, as it will certainly influence the direction of Mortgage Bonds. A convincing break above the 200-day Moving Average would be troublesome for Bonds, as the next move higher for Stocks could be to test the January highs. This means that Mortgage Bonds could give up .25 - .50% in rate, should this take place. But another failed attempt at the 200-day Moving Average – and there have already been a couple in the past few weeks – should give Bonds a boost and help them move towards last week’s highs.

Also helping Bond prices this morning are investors growing concerned with Spain. There is speculation that a bailout is being prepared for the country, even though the European Central Bank insists that a scheduled meeting this Friday with the International Monetary Fund and Spain has nothing to do with a bailout package. However, the markets may not be buying the ECB's denial, as Spanish Bond prices fell sharply today. This news has sparked some safe haven buying in the US Bond market. News from Europe will continue to cause more volatility in the marketplace. It’s difficult to get Europeans to adopt meaningful austerity measures. Just today, France announced their big move towards austerity – an increase of retirement age from 60 to 62, by 2018. If you are laughing, we don’t blame you…but the situation is far from humorous.

Back at home, we had some economic releases, starting with the Producer Price Index (PPI). The headline number dropped 0.3%, when economists were looking for a 0.5% drop. Be mindful that energy prices have moved higher in recent weeks, so we may see a pickup in headline PPI next month. When stripping out volatile food and energy costs, the Core rate rose to 0.2%, above the 0.1% expected. On an annual basis, headline PPI rose 5.3% and in line with estimates. And the year-over-year core reading was 1.3%, slightly above forecasts but still near the lower range of the Fed's comfort zone. Tomorrow brings the more closely watched Consumer Price Index (CPI).

Housing Starts in May were 593,000, well below the 655,000 expected. That number is down 10% from the prior month's reading, but still up 7.8% year over year. Building Permits were 574,000, well below the 631,000 that were expected. Another interesting way to view these numbers is to take housing starts as a double edged sword. While more housing starts would show expected optimism from builders, fewer starts and permits are not necessarily all bad news. Adding less supply and inventory may be healthier in the long run, and aid in moving some of the existing homes in the marketplace.

Industrial Production and Capacity Utilization were both reported higher than expectations, suggesting a pickup in manufacturing and output. The positive readings did help Stocks recover from their worst levels, and this is a good leading indicator that could bode well for the future.

Next Wednesday the Fed will release their interest rate decision and Policy Statement. There is speculation that the Fed may lower their 2010 and 2011 growth targets for GDP. It was just two months ago – in April – that the Fed raised their 2010 GDP projections to a range of 3.2 - 3.7%. A possible cause for the Fed to lower their target would be the significant slowdown in Europe and weakness in the Euro. This has caused the Dollar to gain strength, making our exports a bit more costly. And lowering the target – along with the most recent disappointing Jobs Report – may give the Fed enough consensus, amidst grumblings from its more hawkish members, to maintain their "extended period" language. In any case, it is all making for a very interesting and important Fed Meeting next week, as it could have an important bearing on the carry trade and the direction of mortgage rates.