Mel's Blog

Mortgage Bonds are currently trading higher in this very volatile environment, but we need to keep a close watch on this as Bonds have already given up some ground after touching the ceiling of resistance located at the upper trend line.  Yesterday, the Fed did indeed drop the Fed Funds Rate by 50bp, bringing it down to 3%.  Within the statement, the Fed said "downside risks to growth remain" and the Fed would "act in a timely manner to address those risks" - meaning the door is open to more Fed cuts if necessary.  After yesterday's Fed decision, Stocks shot higher and Bonds moved sharply lower - but things changed very quickly at around 3:30pm ET when it was reported that Bond rating agency, Fitch, cut their credit rating on FGIC Corporation and it's financial guaranty insurance subsidiaries.  This news sparked a selloff in Stocks with the financial sector taking the brunt of the losses.  This trading action helped Bonds improve from their worst levels of the day.

This morning, the bad news continued for Stocks, and there is a developing situation that could have serious repercussions for the financial system. On the heels of yesterday's surprise downgrade, Bond insurer MBIA Inc just reported a $2.3 Billion loss for its fourth quarter earnings due to heavy losses from the sub-prime mortgage assets it guarantees.  This has investors extremely concerned about possible further downgrades for the bond insurance companies from credit agencies.  And new downgrades to bond insurers like MBIA could cause a cascading effect where downgrades and lower ratings applied to existing mortgage investments could trigger another round of mortgage-related losses and write-downs for the large financial institutions totaling an estimated $265 Billion.   Why are the Bond insurers, also called mono-line insurers, so important?  Imagine that you own a home and heaven forbid, suffer a major loss that you turn to your insurance company to cover.  But what if your insurance company themselves have become financially weak or insolvent, and are unable to really help mitigate your loss, due to their own financial problems?  This is exactly the issue at hand.   

In today’s economic headlines, the highly anticipated Core Personal Consumption Expenditure Price Index (PCE) for December matched consensus estimates of 0.2%, resulting in a 2.2% year-over-year Core rate. This is still above the Fed's desired target zone of 1 - 2%, but the good news is that it did not increase from last months year-over-year Core reading. Personal Income and Spending rates for December were slightly higher than forecast with Income rising by 0.5% with Spending rising by 0.2%.

Adding selling pressure to Stocks was this morning's Initial Jobless Claims which were reported at a whopping 375,000, which was well above expectations of 320,000 and the highest weekly increase since September 2005.  The four-week moving average climbed to 326,000 claims.  The weak data may need to be taken with a grain of salt as the Labor Department cited data gathering difficulties due to the Martin Luther King Holiday.  

The Chicago Purchasing Managers Index (PMI) for January was reported at 51.5 which met expectations.  

Jobs Report Strategy

There has long been a "conspiracy theory" that the Fed has access to economic data in advance of the official release dates.  And tomorrow morning, we will get some clues as to the validity of this theory.  The Fed went ahead and cut by 50bp yesterday, which would be justified by a weak Jobs Report tomorrow, and add some validity to the theory.  However, if the Jobs Report comes in hot, as portended by Wednesday's ADP Report...it would shoot down any notion of truth behind this conspiracy theory.  Consensus estimates for tomorrow's official report are for 70,000 new jobs created during January. 

As for me - I have fears of a hot number, in part due to the averaging issue I discussed in yesterday's Update, as well as the lower Initial Jobless Claims numbers we've observed throughout January.  Particularly because Bond prices are trading near the best levels seen in several years - I will take a conservative approach, and have a Locking bias at the end of the day, ahead of tomorrow morning's Jobs Report.