Volatility continues to describe the financial markets; this morning in early activity the stock index futures pointing to a down open, treasuries and mortgages continue to improve. Yesterday the Fed shocked markets by actually setting a long term time frame to keep the FF rate at current levels, saying the Fed would hold until mid-2013. I can't recall anytime where the Fed did that; generally the Fed uses more ambiguous language like "extended period of time" to signal its intentions; leaving markets to determine what that meant.
The reaction to the statement at 2:15 yesterday sent the stock indexes higher and took interest rates to lows not seen since Dec 2008; the 10 yr at one point hit 2.03% before backing up to close at 2.27% down 6 bp. Mortgage prices climbed and held gains, up 1.03 bp on 30 yr Fannies. Early this morning (9:00) mortgage prices up 15/32 (.47 bp), the 10 yr note +29/32 at 2.17% -10 bp.
At 9:30 the DJIA opened -200, the 10 yr note +33/32 at 2.16% -11 bp. Mortgages are on fire, up 21/32 (.6 bp) after climbing 1.03 bp yesterday. The spread between MBSs and treasuries is narrowing on the Fed decision yesterday, investors can increase returns over treasuries by moving to MBSs. The swift decline in mortgage rates will set off another re-finance market; the lower mortgage rates are the lower the risk for investors, so MBSs at the moment are very attractive.
Various opinions yesterday and this morning trying to handicap the Fed's surprise yesterday. The obvious is that the Fed now does not expect any real improvement in the economy for a year or more. The Fed did however, say it would continue to monitor markets and would, if the economy actually grows and unemployment declines, be quick to signal a change in thinking. Telling markets the FF rate would stay at present levels for two years implies the economy isn't likely to improve much and inflation will not increase. The FOMC vote was not unanimous though; there were three members that voted against the decision; suggesting the Fed is becoming increasingly divided in its outlook and decisions on monetary policy.
Our take on the Fed's decision yesterday; the Fed is essentially out of bullets that they believe will help revive the economy and lower unemployment. There are however a number of analysts believing the Fed will do another easing later this year; whether it does or doesn't any easing won't help the economy. I believe what Bernanke did is to assure investors rates will stay low and that putting money in treasuries won't provide much, if any, return on parking money. Investors will continue to look for any potential to earn some profits, that makes stocks more attractive; not because the economy will drive equities much higher, but equities will at least allow trading opportunities and stocks that pay dividends will provide better returns than treasuries. Bernanke's decision will keep interest rates low and likely keep the stock market from collapsing. We believe equity markets will trade in a very wide range, a wide enough to provide opportunities. That said, the economic outlook at the moment is such that the key indexes have little chance of making new highs but equally won't likely crash. It was a excellent strategic decision by Bernanke.
Continue to expect extreme volatility in both stocks and interest rates over the next week or two. The week ahead will likely see two way trading; up and down with little change but the daily swings are going to be huge compared to norms. Yesterday a prime example, the DJIA had a 600+ range closing up 429 after dropping 634 points Monday, and down 1000+ points since last Thursday before yesterday's gain.
At 10:00 June wholesale inventories, expected +1.0%, were +0.6%; sales also up 0.6%.
At 1:00 Treasury will sell $24B of 10 yr notes; yesterday the 3 yr auction went well, we expect the 10 today will also see strong bidding.
At 2:00 Treasury will report the July budget; a shortfall of $132B is expected.
How low can rates go? Not sure, but it is likely the 10 yr note rate will fall to 2.00%; it could fall further depending on what happens in Europe and the US economic outlook. Right now MBSs are seeing strong buying as investors seek higher yields. Volatility will continue so be prepared for wide swings.
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