Mel's Blog

Mortgage Bonds are following through on Friday's gains and are now trading at the best levels since August 2005.

News about Citigroup is circulating this morning that the company may have to write off another $24 Billion in sub-prime mortgage related losses.  This may prompt a restructuring where up to 20,000 employees may be at risk of losing their jobs.  Plus, Citigroup may be forced to pare back its dividend payment while seeking a capital infusion by selling as much as $15 Billion in stock to outside investors.  This is the type of news that tends to undercut investor confidence in stocks while providing an underlying boost for bonds.   Although today Stocks are showing some strength on the heels of better than expected earnings from IBM.

There are no economic reports scheduled for release today, but the remainder of the week heats up starting with tomorrow’s release of the Producer Price Index (PPI) and Retail Sales reports.  Then on Wednesday, an important read on consumer inflation will be delivered by way of the Consumer Price Index (CPI).  With a Fed cut coming on January 30th, this CPI report will be very interesting to follow.  If consumer inflation is continuing to heat up, a .50% cut may come off the table - even in the face of a softening economy.

Today, the Fed will be auctioning $30 Billion of 28-day credit through its third Term Auction Facility (TAF), a new monetary policy tool designed to alleviate pressures in the inter-bank credit system.  To be specific, since the Fed has instituted this in December LIBOR has come down over 100bp...kudos to Chairman Bernanke and the Fed.  The Fed stated they will announce on Friday, February 1 whether or not they will conduct any further TAF auctions in February.  

Technically, Bonds are just 6bp below the top of the Rising Channel they have been in since mid-2007.  A six month view on the Bond page clearly illustrates this.  The Bond could ride another 6bp higher before pressing against this very serious ceiling.  I am floating for now, but be ready to lock as prices could move sharply lower from these lofty levels once the ceiling is hit.

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.

It's Fed Day afternoon...and one of the most highly anticipated and hotly debated Fed Decisions will be released at 2:15pm ET.  It's interesting to see the parade of fools come on the air, who earlier this morning said that a Fed cut of 50bp would immediately cause home loan rates to drop by 50bp as well.  Scary.  Let's first get to the news - then I'll talk about what the Fed might do, likely market reaction, and what we should be saying to our clients.    

The ADP Employment Report was released this morning, suggesting that Friday's official jobs number should come in around 150,000 new jobs - which is more than double current consensus estimates.  While this shows employment growth in the economy, the problem with the jobs numbers is in the inevitable revisions to follow, in that the tabulation includes previous averages - as opposed to actual numbers.  It's kind of like a meter reading on your home utility...sometimes you get an actual reading, sometimes you get an estimate based on previous usage.  In times of economic growth, the average understates the amount of new jobs, because it's based on lower levels.  Conversely, and as we find ourselves today, in times of economic slowdown, averages are predicated upon higher levels, therefore overstating actual job creations. 

But the ADP Report - while interesting - took a back seat to the more reliable and much weaker than expected 4th Quarter GDP Report.  Fourth quarter GDP showed a 0.6% annual growth rate, almost half the 1.1% growth rate expected by economists and far below the 4.9% rate recorded during the third quarter.  Overall, GDP grew by only 2.2% during 2007, the slowest growth rate since the economy was coming out of a brief recession in 2002.   

So what will the Fed do?  The Fed Funds Futures contracts is pricing in an 80% chance of a 50bp cut, and a 20% chance of a 25bp cut.  I think a 50bp cut is likely - but should we get a 25bp cut, the statement will probably contain language that the Fed will cut further if necessary.  Neither of these is very good for the long term future of mortgage rates, due to the eventual inflationary pressures the cuts will create.  And Bond Traders will eventually be smart enough to figure that out. 

I feel a 50bp cut is in the cards, which will take the Fed Funds Rate down to 3.0%.  This would be a big help for business loans, consumer loans, Home Equity Lines of Credit and Adjustable Rate Mortgages.  But how will this affect your fixed rate sheet today?   As we have said for years, Fed Rate cuts do not have a direct impact on fixed mortgage rates.  In fact, they often serve to push them in the opposite direction, by fanning fears of inflation when they cut - or by fighting inflation when they hike.  Fixed mortgage rates are directly affected by inflation, because a fixed rate mortgage provides the investor with a fixed rate of return for a long period of time.  As inflation increases, the buying power of that fixed return is eroded, because it costs more dollars to buy the same amount of goods and services.  So if inflation is on the rise - investors will demand a higher fixed rate of return to compensate them for the more rapid erosion of buying power on their return. 

The last time the Fed had a long cutting cycle was back in 2001.  The Fed cut eleven times in eleven months, and eight of those cuts were by 50bp, for a total of a 4.75% drop in the Fed Funds Rate.  But mortgage rates were actually higher throughout this drastic cutting cycle, because inflation ticked higher.  Let's look at more recent history, and as we have pointed to previously:  the Fed cut by 50bp on September 18, 2007, and after prices enjoyed a move higher that afternoon, Mortgage Bonds lost 94bp over the next two days.  On October 31st, the Fed lowered by 25bp...and over the next five trading days, Mortgage Bonds lost 78bp.  On December 11th, the Fed lowered by another 25bp, and over the next two days, Mortgage Bonds lost 64bp.  Most recently - the surprise 75bp cut by the Fed cost us about 150bp on our rate sheets over the next two days. 

This is all the evidence you need to get your clients off the fence, and into application.  That said, Bond prices may have an initial move higher after the Fed announcement.  So for now, I will float and watch carefully.

Mortgage Bonds have traded wildly up and down over the past six days.  So if you like volatility, this market is for you.  Mortgage Bonds are now trading lower after this morning's Durable Goods release, which was reported well above expectations.  It is known that, the Durable Goods Report is a volatile one, but the 5.2% reading was far above expectations of 1.2% and could signal that business capital investment is picking up or paint the picture that the economy is not as bad as previously thought.  This translates to even more guessing about the Fed's decision tomorrow.  Will it be a cut of a quarter or a half percent?

The consumer is still feeling pretty confident as Consumer Confidence for January was reported at 87.9, which was stronger than expectations of 87.0.  Adding further strength to the report is an upward revision to December's reading from a previously reported 88.6 to 90.6.  This morning's stronger than expected report has to raise some eyebrows at the Fed, which starts their two-day meeting today. 

The Fed’s interest rate decision and Policy Statement is set for release tomorrow afternoon at 2:15pm ET.  At least two former voting Fed members see a half point cut to keep the markets from going back into the sharp decline we had seen just last week.  And the futures contract, which is not so good at predicting longer term Fed moves, but very good at the near term move, is pricing in an 86% chance of a 50bp or half percent cut...I see this scenario playing out as well.  

If the Fed does cut by 50bp - the long term picture may not be so good for Mortgage Bonds.  The Fed has already cut 175bp since September 18th, bringing the Fed Funds Rate down to 3.5% from 5.25%.  And don't forget the 50bp cut in just the Discount Rate back in August.  Add in the President's Stimulus Package and another 50bp cut tomorrow and you have a whole lot of ammunition to juice the economy.  Remember that it takes 6 to 9 months for the effects of a Fed Move to be realized.  And we are barely 4 months past the initial Fed cut.  If inflation flames arise, bond prices will suffer later, as the fixed rate of return they generate must yield a number to compensate for higher inflation.

And in watching many so called experts parade in front of the news cameras this morning, it was funny to hear some of the comments.  An economist from S&P said that most mortgages are priced off the 10-year Note...scary.  Another said the Fed's recent cut (exactly one week ago) has had no effect on housing.  Again, this shows how little understanding these individuals have about the way our business works.  Do they really think that people see the Fed cut, get in their car, buy a home, get a mortgage, and close within a week?   

Note the Floating Bias today - this does not mean to take your eye off the ball as we are already seeing a decline in MBS prices.  This is a good time to get the message out to your clients, who may be waiting on rates to drop further.  As always, loan applications never peak at the lowest point for rates...they do so when rates start moving up and clients get off the fence before the train leaves the station.  Warn your clients of this common error.  It is wise to have your clients in queue, especially those above $417k, but below $625K.  This way they can pounce on the lower rates once the conforming limit is raised.    

Brace yourself for another wild ride.  This week's economic calendar is steaming with volatile reports stacked every day.  The reports include, Wednesday's Fed rate announcement, Thursday’s Core Personal Consumption Expenditure (PCE) Index and Friday’s Jobs Report.  That's a huuuuge list.  And how about the movements we saw last week.  Every trading day had interest rate moves of at least a quarter percent...again, that's in rate!  

Kicking off the week was the New Home Sales Report for December, which came in at 604,000, below expectations of 645,000.  The supply of new unsold homes rose to 9.6 months from November's reading of 9.3 months. 

At the height of last week’s stock market panic sell-off, Fed Funds Futures traders were pricing in another 50bp rate cut by the Fed for when they meet this Wednesday.  Now, however, the Fed Funds Futures have cooled and are pricing in just a 25bp rate cut.  This has caused some uncertainty in the markets as to which way the Fed will go.  With inflation still a real and present concern, it is very difficult to handicap this.  And predictions from highly regarded economists range from no cut at all to a 75bp cut.    

Speaking of the stock sell-off, was "rogue trader" Jerome Kerviel really solely responsible for costing French Bank Societe Generale $7.1 Billion Dollars...and for helping to trigger last week's massive decline in the global Stock markets?  Or is the junior trader being played a fool, becoming the scapegoat to cover up financial mismanagement by the bank itself?  Supposedly - the French Bank had just uncovered massive losing positions caused by Kerviel, and decided to start selling off or "unwinding" these losing positions last Monday.  Initially the loss was estimated at about 1.2 Billion British Pounds, but the decision to unwind the positions in a less liquid market, because our US markets were closed on Monday in observance of Martin Luther King Day, turned the loss into 3.7 Billion British Pounds or $7.1 Billion US Dollars.  The media didn't understand what happened and said the cause was that the global markets suddenly realized that the US was likely headed towards recession. 

For now I will float and watch carefully as things develop.

History has a way of repeating itself.  On Tuesday afternoon when Mortgage Bonds were trading 53bp higher, our alert to float also discussed what happened back on September 18th, the last time the Fed surprisingly cut rates by .50%.  On the day of the cut, Mortgage Bonds had traded nicely higher, but on the next day, and after a higher open, Bonds went tumbling lower.  This is exactly what happened again yesterday as Mortgage Bonds opened 38bp higher and then suddenly reversed 94bp  lower on the dramatic recovery in the Stock market.   Take a look at the chart below and be sure to share this with the clients and relationship partners you protected over the past two days.  

In this morning’s economic news, Initial Jobless Claims were reported at 301,000, which was below expectations of 320,000 and represented it's fourth consecutive weekly decline.  Meanwhile, the widely watched four-week moving average of Initial Jobless Claims also declined with 14,000 fewer claims to a level of 314,750.  The better than expected results added some more selling pressure to the Bond market.  

Existing Homes Sales for December were reported at 4.89 Million, which was just slightly below expectations of 4.95 Million.  The monthly inventory of unsold homes fell to a 9.6 month reading from November's reading of 10.1.  For all of 2007, existing home prices fell 1.8% and represented the first nationwide decline in houses since the Realtors started tracking this data over 40 years ago.  But think of this, we have experienced historic gains of over 100% in the past several years in many parts of the country, so how bad is a 1.8% year over year decline.  If the Stock market doubled in the past three years and the market then declined 1.8% - would it even make the headlines?  Think about this and be sure to share it with your clients and relationship partners the great opportunity upon us.  We are seeing a buyers real estate market along with mortgage rates at three year lows. 

Speaking of opportunity.  I am hearing rumors that the conforming limit may be raised on a somewhat temporary basis from $417,000 to $625,500, like it already exists in Alaska, Hawaii, Guam and the Virgin Islands.  I have been beating the drum on this for some time and many of you have taken the material and letters that I have provided on the site and contacted your State representative requesting this important change.  You all deserve credit as it appears that our efforts are not falling on deaf ears.  Now remember, this is still just a possibility and it may not even happen, but we have to be ready.  I strongly recommend you start lining up all your Jumbo and ARM clients as this opportunity would in essence represent a 1% reduction in interest rates.

Hopefully, you have acted on my recent advice and protected your entire pipeline.  But even on new transactions I am going to keep my bias towards locking as the Bond has some more room to fall as the next clear floor of support lies at the 25-day Moving Average, presently around 80bp lower than current levels.  

Just look at your rate sheet...a thing of beauty.  It's also nice to know that 60% of competitors from a couple of years ago are gone.  As I have said in the past, 2008 looks very similar to 1993, which was an awesome refi year.  That said, we will need to proceed very carefully to protect the pricing we currently see.

Stocks opened significantly lower, but have cut their early losses.  And as you might expect, Bonds surged higher, but have given up some of their gains as stocks have improved.  This means we will need to be guarded against a possible re-price for the worse later today.  Count on us to watch the market for you while you dial for dollars and add refinances to your pipeline. 

Technically, Bond prices have been on an amazing run - shooting almost 400bp higher since Christmas.  An upward move like this is often followed by some sort of correction.  And volatility only increases from these lofty levels.  

In a surprise move this morning - The Fed cut the Fed Funds Rate by .75%, lowering it to 3.50%.  The Fed decided to hold a special meeting last night as US Stock futures were trading significantly lower and Stocks around the world sold off sharply yesterday and this morning as foreign countries fear a US recession.  This morning's Fed cut was the first intermeeting Fed action since September 17, 2001, and the deepest one day Fed Cut since 1984.  It should also be noted that the vote to cut wasn't unanimous as St.Louis Fed President Poole dissented against the cut and preferred waiting until next week at the normal scheduled meeting.

Here's the brief statement the Fed delivered this morning with the Cut:

The Federal Open Market Committee has decided to lower its target for the federal funds rate 75 basis points to 3-1/2 percent.  The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth.  While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households.  Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets.  The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.  Appreciable downside risks to growth remain.  The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.

In addition to cutting the Fed Funds Rate, the Fed also cut the Discount Rate, the rate member banks can borrow directly from the Federal Reserve, to 4.0%.  This move should provide further stimulus to the credit markets.

The Fed Funds Futures are still fully pricing in another 50bp cut at next week's meeting, which would lower the Fed Funds Rate to 3%.  This is interesting with inflation still a concern.

Stocks took a beating at the open this morning, and at one point traded at the worst levels since January 2000.  But the selloff would likely have been far worse if the Fed had not stepped in.  You may recall the Stock chart we included in last Friday's update, which highlighted the Up Escalator Stocks have been riding on for three years.  Stocks have fallen beneath this important level of support this morning, however Stock prices are attempting to rebound and are well above their worst levels of the day.   

This morning's stock selloff has caused Mortgage Bonds to rally higher with prices at the best levels since June of 2005.  Additionally, LIBOR which was 5.15% just a few weeks ago, is now 3.71%.  In this sea of fear, this is some good news to share with your clients and relationship partners.

Treasury Secretary Hank Paulson is also in the news this morning saying he, and his team at the US Treasury, has been monitoring the global sell-off in stocks.  Perhaps in an effort to stem the global panic selling that has been taking place and to restore confidence in the US economy, Paulson said he will move to carry out an economic stimulus plan "as soon as possible."  Paulson stated he is optimistic a plan can be implemented with Congressional approval "long before winter turns to spring." 

I recommend we continue to Float, but we need to be prepared to lock should things change.  Stocks are very volatile and any further improvement could be at the expense of Bonds.   

Mortgage bonds are a bit lower this morning after a higher open in the stock market as well as responding to technical signals.  Prices remain overbought and near the high of the trading range, so we need to be on guard for a move lower and stand ready to lock.  

In economic headlines this morning, the Index of Leading Economic Indicators (LEI) for December was -0.2%,  which was less than the -0.1% expected.  The reading points to the probability of a recession ahead.  In other news, The  University of Michigan ’s Consumer Sentiment Index for January was reported at 80.5, much better than expectations - so it appears that some consumers may be feeling a bit more optimistic.       

If you caught the testimony by Ben Bernanke yesterday at the House Budget Committee hearing, you may have been as amused as we were upon hearing the bonehead questions.  It's bad enough that most elected officials can't even say our Fed Chairman's name correctly, but when they mistake the Fed Chair for the Treasury Secretary, it is a sad state of affairs.  Yes it's true, Representative Marcy Kaptur (D) from Ohio was addressing Bernanke as if he were Paulson.  And we actually vote for these people.   

Let's take a look at the chart below of the S&P 500 for the past 3-years.  Notice how prices have been on an Up Escalator - just like mortgage bonds of late.  The recent drop in stocks was halted exactly at the bottom of the trading range yesterday and prices are rebounding higher this morning.  Let's keep a watch on this.  Should stocks begin to march higher, we will likely see mortgage bonds worsen...both moving within their respective channels and bouncing off the limiting boundaries.  If stocks fail to stay within the current trading range and break lower, Bonds may do the opposite and break higher out of the current range.

As discussed above and over the past few days, Bond prices are still in a position for some sort of correction lower, which makes my float position...very, very, cautious.  Longer-term, Bonds can certainly improve, but with Stocks so ready for a bounce higher, we could see Bond prices move lower in the short-term.

Later today, President Bush will be announcing the principles of his economic stimulus package to avoid a recession.  I will be watching for market reaction.

Massive volatility remains the name of the game - and will likely continue.  After Bonds fell sharply lower yesterday and opened lower today, prices have now rebounded higher off Fed Chairman Ben Bernanke's testimony before the House Budget Committee, combined with an ugly Philadelphia Fed Manufacturing Index.  

A few highlights from Bernanke's testimony - the December Jobs Report was disappointing to the Fed, and the outlook for the economy in 2008 has worsened.  He indicated no recession but slow growth, as he feels that overall, the US economy remains resilient and has inherent strengths.  He confirmed that additional rate cuts may be necessary while knowing that inflation is still a risk, but feels that overall headline and core inflation should moderate.  Bernanke's "no recession" comment is very interesting, but he has been optimistic all along...perhaps a little too optimistic, as he has now been proven wrong on his thoughts about the credit markets.  Additionally, Bernanke's comments underscore the conundrum I have often framed here, in that the fight against recession is being done with a hand tied behind the Fed's back, due to pesky inflation.  So - if you read between the lines - Bernanke's comment of "no recession" means that upcoming Fed cuts may not be as deep as the market would like to see.  Therefore some anxiety selling was created in the Stock market, which is transferring into the purchase of Bonds, helping prices improve this morning. 

Also helping Bonds this morning was a downright terrible Philadelphia Fed Manufacturing Index, which was reported at -20.9 and far below expectations of -1.5. 

And as if that weren't enough already, Housing Starts were reported at 1,006,000, which was lower than expectations of 1,150,000.  This was the lowest number of Starts in about 16 years.  Building Permits were not much better, as they fell by 8% to an annual rate of 1,070,000, their lowest number in 12 years.  While many pundits and media moguls will be quick to point to this number as evidence of further demise within the housing market - we think it is actually a very good sign.  High inventory is a problem for the real estate market - so less new inventory coming on the market will be a positive for those who see the opportunity in the future.

Initial Jobless Claims, a volatile number, surprised with a better than expected report of just 301,000 filings for new unemployment benefits.  This number is a bit of an enigma, after watching job growth weaken and the unemployment rate spike.  Let's keep an eye on this trend.  

Amidst all the economic noise, the markets are figuring a 50bp rate cut on January 30th is in the bank.  I agree. 

Technical signs clearly indicate that the Bond is being stretched and priced for perfection.  The "leash effect" has been a very accurate indicator that prices will soon pull back towards the 25-day Moving Average, and we are close to seeing that happen.  The top of the channel shown on the Bond Page has been a strong, almost impenetrable ceiling, and the Bond is clearly in an overbought state.  Because of the current price appreciation, I am floating, but with a finger on the lock trigger, as it would not surprise us to see more volatility and perhaps an afternoon reversal. 

Bonds are presently trading just slightly lower, but are well off the best levels reached earlier this morning, before the inflation measuring Consumer Price Index was reported a bit hotter than expectations.

The headline Consumer Price Index (CPI) for December was reported up 0.3%, which was slightly higher than expectations of 0.2%, and the highly watched Core CPI for the month met expectations of 0.2%.  But the real story lies in the year-over-year numbers.  During the past year, headline CPI rose by 4.1%, which was its largest annual gain since 1990, and largely due to higher energy costs...and even when pulling out food and energy, the more closely watched year-over-year Core CPI was reported at 2.4%.  

This has to raise the eyebrows of the Fed, as this year-over-year Core number has edged higher from the 2.1% reading seen in recent months.  The markets are fully anticipating a .50% Fed cut on January 30th in an effort to avoid an economic recession, but the Fed has to weigh its cutting measures against the reality of increasing inflation.  Remember, when the Fed cuts rates, it can lead to more inflation, as goods and services become cheaper to finance, therefore driving more demand and in turn, higher prices.  So the Fed has quite a balancing act on their hands - and for now, Bond Traders are taking some profits off the table from the recent gains in Bonds, knowing that upcoming Fed cuts could add further inflationary pressure.

In other news, Industrial Production for December was reported unchanged and slightly higher than expectations.  Capacity Utilization was reported at 81.4%, which was also slightly better than expected.  The 81.4 reading remains below the 85 level consistent with inflationary pressures.  At 2pm ET, the Fed's Beige Book, a report on current US economic conditions, will be reported and could have an influence on the market later today.  

Mortgage Bonds are in rally mode this morning after a string of weak economic reports.  Retail Sales, NY State Manufacturing Index, along with worse than expected earnings from Citigroup, are all hurting Stocks and helping Bonds.  Additionally, the Producer Price Index (PPI), which measures wholesale inflation, gave a modest reading on inflation in this area.  It should be noted that this is a very volatile report and tomorrow's CPI will carry a lot more weight.

The weak economic picture painted from this morning’s news should give the Fed reason to cut rates by .50%, and in fact, there are rumors swirling that the Fed may hold an emergency meeting and cut in advance of the scheduled January 30th Meeting.   Although we don't see that as likely.

Retail Sales in December fell by 0.4%, which was well below expectations of a 0.1% gain and represented the first drop in six months. After subtracting the effect of auto sales, Retail Sales also fell by 0.4%.  For the entire year, Retail Sales showed their weakest growth in five years with an overall annual growth rate of 4.2%. 

As mentioned above, the Producer Price Index (PPI) was reported -0.1% during December, which was lower than expectations of 0.2%.  When excluding volatile energy and food prices, the Core PPI only rose by 0.2%, matching the consensus forecast.   It will be interesting to see if the moderation in wholesale inflation is transferred to tomorrow's more closely watched Consumer Price Index (CPI).

The New York Empire State Manufacturing Index was reported at 9.0, which was just slightly below expectations of 10.0.  Readings over zero indicate growth in manufacturing while those below zero indicate contraction.  The percentage of firms surveyed that are expecting manufacturing conditions to worsen rose from 16% to 24%.  

Also in the news, the earnings report from Citigroup is adding selling pressure to the stock market after the company announced a $9.8 billion loss for the fourth quarter along with slashing their dividend by a whopping 41%.   Losses stemming from faulty sub-prime mortgage investments forced Citigroup to write-down $18.1 billion in these assets.  The company is also setting aside another $4.1 billion to cover anticipated losses in their consumer loan portfolio.  In an effort to improve its deteriorating balance sheet and capitalization, Citigroup also announced it raised $12.5 billion from a private placement and public offering of preferred shares.  As a result of this bad news, money is coming out of the Stock market and is being parked into Bonds.  

Bond prices continue to march higher and are now at the highest levels since June 2005.  I will continue to float, but be ready to lock, as prices are technically overdue for some sort of correction lower. 

High volatility in the Bond Market continues.  Mortgage Bonds have regained the ground they lost yesterday as Stocks trade lower on the heels of another round of sub-prime mortgage related corporate losses.

The New York Times is reporting Merrill Lynch, the country’s largest brokerage firm, will report losses of about $15 billion when they report earnings next week.  Sources close to the company are saying the losses are twice what was originally estimated and originate from bad mortgage investments.  The losses may force the company to seek additional capital from outside investors. 

Big news for our industry...Rumors were confirmed that Bank of America, the largest consumer bank in the US , announced it will buy struggling Countrywide Financial for $4 Billion.  This buyout should help to stabilize Countrywide and prevent the company from slipping into bankruptcy.  

High imported oil prices caused the Balance of Trade to show more red ink than usual during November.  As a result, the trade deficit widened by 9.3% to -$63.1 Billion, its highest level in more than a year.  Economists were expecting a -$59.5 Billion deficit.  The significantly larger trade deficit will likely lower Fourth Quarter GDP growth from it's current estimates of 1.2%.  

Fed Governor and voting FOMC member Frederic Mishkin is scheduled to speak at 12:45pm ET and Boston Fed President Eric Rosengren is speaking at 1:00pm ET.   These speeches could have an impact on the markets.

Technically, the Bond is testing a tough band of overhead resistance at multi-year highs.  I will float, but cautiously, as prices have been unable to convincingly break above this nearby ceiling.

Mortgage Bonds are trading lower as Stocks have reversed higher.  After failing to break above resistance the past couple of days, the Bond finally broke down yesterday and confirmed the topping out pattern we have been seeing. 

The markets are awaiting the main event of the day - a speech by Chairman Ben Bernanke.  At 1pm ET, the Fed Chairman will talk about the financial markets, US economic outlook and monetary policy.  This speech could move the markets as Traders will be looking for clues or hints about where the Fed will take interest rates when they next meet on January 30 to decide monetary policy.  

“What’s in your wallet?”  A profit warning from Capital One Financial Corp. said it will take a $1.9 billion provision for fourth quarter loan losses including a $1.3 billion in write-offs. 

Initial Jobless Claims were reported at 322,000 claims, which was below expectations of 337,000 and the lowest weekly total since November 3.  The four-week moving average for claims dropped to its lowest level in a month by falling 3,000 claims to 341,000.  

Technically, a Negative Stochastic Crossover suggests that Bond Prices have topped out and could move even lower.  This afternoon's speech by Ben Bernanke could have a big effect on the direction of all the markets

Mortgage Bonds are trading lower and appear to be losing their upward momentum.  There are no economic reports scheduled for release today, so Bonds may have a difficult time breaking above a nearby tough ceiling of overhead resistance.  

Goldman Sachs is in the news this morning predicting a recession for 2008 along with a growing unemployment rate to reach 6.5% by 2009 from the current rate of 5.0%.  Goldman is also forecasting the Fed will continue to slash the Fed Funds rate until it reaches 2.5% by the third quarter of this year in an effort to achieve a “soft landing” for the economy.  According to Goldman, this would mean the Fed will cut Fed Funds by another 1.75% from their present level of 4.25%.   That would be aggressive for a Fed that is also very mindful of rising inflation pressures.  But the folks at Goldman are very smart and have a great track record.  It will be interesting to see this play out.

Earnings season for the Fourth Quarter starts today with aluminum-maker Alcoa, kicking it off later this afternoon.  Corporate earnings are expected to decline by -9.8% for S&P 500 corporations over third quarter results.  It will be interesting to see how the markets react to the numbers and future guidance, as Stocks have already been beaten down to start the year. 

Bonds have not closed lower over the past eight consecutive trading sessions - a very remarkable and rare occurrence.  It also means that Bonds are even more ripe for some sort of correction lower.  Over the longer-term, prices may continue to move higher as the Bond still rides the Up Escalator.  But in the shorter-term, the Bond is more susceptible to a move lower.

Mortgage Bonds are trading lower this morning as they take an overdue breather after their sharp run higher.  

This morning, Philadelphia Fed President Charles Plosser confirmed what we have been saying for some time - the Fed is in a tough spot with regards to monetary policy because the economy is slowing at the same time inflation is rising.  Mr. Plosser confirmed that additional cuts are a possibility in response to weakness in economic activity but also said "we must remain vigilant on the inflation front and be prepared to act as necessary to avoid the risk of undermining public confidence in the central bank's commitment to price stability," - this means if inflation continues to heat up, further rate cuts are likely off the table.  Later this morning, Boston Fed President and new voting member for 2008, Eric Rosengren is scheduled to speak and his thoughts on monetary policy could cause some market movement.  

Pending Home Sales for November were reported down 2.6%, which was worse than expectations of -0.8%.  But there was a huge upward revision to October's number to 3.7% from a previous reading of just 0.6%. 

The Bond is showing signs of losing its momentum while trading within an “overbought” position.  Additionally, prices have further separated from it's 25-day MA, which makes the Bond even more ripe for a correction lower.  With resistance at $100.91 just overhead, it may be prudent to lock and take advantage of the recent gains.

Mortgage bond prices are jumping higher this morning following a dismal Jobs Report.  

New job growth in December was reported at a paltry 18,000 jobs with private-sector job growth actually falling by 13,000, the largest private sector drop in more than four years.  The estimates were for 70,000 new jobs.  As a result of the decline in jobs in the private sector, the Unemployment Rate jumped significantly to 5.0% from November’s level of 4.7%.  The consensus estimate was 4.8% for Unemployment. 

Hourly Earnings actually moved higher again by 0.4%, versus the estimate of 0.3%.  This is contradictory to the slowing jobs number and suggests some wage pressure inflation.  Perhaps employers are trying to save money by paying more to fewer workers.  The average hourly amount of earnings now stands at $17.71.  The Average Workweek matched consensus estimates of 33.8 hours.   

Overall, this was a very weak Jobs Report and bonds are pushing higher.  Clearly I was wrong by taking the safer lock bias yesterday, which was more a result of weighing the current 25bp gain against the potential 100bp loss if the Jobs number were stronger.  

ISM Services for December  was reported at 53.9, higher than expectations of 53.5.  The report is bullish on the economy, but the market had little reaction as the Jobs Report has set the tone for the day.  

Federal Reserve Governor and FOMC voting member Donald Kohn is scheduled to speak at 11:15am ET.  Any comments he makes about the current state of the economy or today's Jobs Report could further influence the bond market.  

Technically, the Bond has broken through a ceiling of resistance and now stands at its best level since September of 2005.  But a few words of caution - the Bond is very overbought, nearing another ceiling of resistance, and has separated from the 25-day Moving Average by 108bp, which may trigger the Leash Effect.  Needless to say that I am floating with a high level of caution, as the Bond may pullback on some sharp profit taking from these levels, which are a result of over 210bp in gains during the past six sessions.  

Bonds have slipped a bit lower after the release of the ADP Employment Report for December, which showed the private sector creating 40,000 new jobs.  This is down significantly from November’s revised number of 173,000 jobs.  After factoring in an average of 25,000 new government jobs created, the ADP Report suggests tomorrow’s Jobs Report will come in around 65,000, essentially in line with consensus estimates.  

In other news, Initial Jobless Claims during the last week of December were reported at 336,000, which was well below expectations of 349,000.  The more significant four-week moving average for claims edged slightly lower to 343,750.  The numbers are reflective of some short-term seasonal layoffs, but balanced by holiday hiring.  

Jobs Report Strategy        

The current consensus estimate is for 70,000 new jobs to be created, but perhaps of greater importance is the hourly earnings number.  Last month's blistering increase of 0.5% sent Bonds reeling, as the fear of inflation loomed.  I feel that this trend may continue.  Although the overall report tomorrow may not be very strong, Bond prices have rapidly reached dizzying heights of late, and Traders may look for any excuse to sell and take profits. 

The safe play from a risk vs reward standpoint is to lock ahead of tomorrow's number.  This is not to say that Bonds can't improve, but I am looking at the amount that could be gained, versus the amount that could be lost.  From a risk management standpoint, I feel it is prudent to protect the price gains we have seen ahead of tomorrow's volatile report, which does not give us the clear clues we have sometimes seen with regard to direction to the report. 

IZZY came and Bonds went.  Mortgage Bonds are starting 2008 with a bang in response to a very sloppy Institute of Supply Management Index Report.  The reading for December was 47.7, which is way below expectations of 50.5 and the lowest reading for 2007.  A reading above 42 still indicates expansion in the overall economy, but the report shows contraction in the manufacturing sector.  On the news, Stocks moved sharply lower and Bonds rallied higher.

At 2pm ET, the Fed will release the minutes from its December 11th policy meeting.  The decision to cut the Fed Funds Rate by .25% at the last meeting was not unanimous among the voting Fed members, so the minutes could reflect some interesting philosophical differences in monetary policy.  Speaking of which, there are some changes at the Fed regarding the rotation of voting members starting the new year and the overall bias may be more hawkish, making the Fed stingier towards rate cuts. 

While today's highlight is the Fed Minutes, tomorrow's ADP Report will give clues on Friday's Jobs Report.  With Bond prices at lofty levels, challenging 2 1/2 year highs, Friday's Jobs report could be the catalyst that causes rates to improve towards refi-mania levels or causes pricing to give up its recent gains.  Stay tuned as tomorrow I will lay out my Jobs Report strategy heading into Friday's important release.