Interest rates are not the main reason for the anticipated slowdown; there is no urgency to move because in most areas prices are not increasing. Most consumers see no potential of increased income and no real improvement in their financial situations. With the increasing lack of confidence in personal growth, the ordinary consumer is unlikely to accept increasing risk while banks will remain very conservative on lending. Federal rules about QMs is a huge anchor for banks to lug around; the uncertainty about the longer term liability for mortgages made is about as stupid a move as I have seen in 50 years of being involved in the business.
The currency war began about five months ago but has only started getting headlines in the last couple of weeks; when the Fed began pulling back. From now on its every country for itself in a move to drive their currencies down to better compete in the export markets. Developed countries that flooded QEs (the US, BoE, ECB, and now the BoFJ among a few others) with billions (a total into the trillions) to keep their countries afloat have supported emerging markets for the last four years. Now the digital money printing is ending; emerging markets are increasing rates to keep foreign investors, while Japanese and even US policies are aiming to drive their individual currencies down. This currency war is just in the very early stages and will likely continue for the next few years. In the end no country will win the war; there is going to be trade tariffs and other ‘tricks’ to compete in the war. The net effect is eventually going to increase global inflation but that is way down the road. We bring it up now only to emphasize the change that is beginning; central banks that have participated in the QE grand experiment are now about to withdraw----slowly, but surely. Whenever major developed-world central banks keep rates at very low levels and weaken their currencies, they cause bubbles.
The central caveat to all this is that if the US economy begins to decline the Fed will not continue to end its monthly purchases, but will believe it necessary to increase them. This is not a global economy that is moving on its own momentum; it is an economy led around by central banks and it cannot last forever.
The technical remains bullish in the near term but, we are watching the strength of the 10 yr note based on its 14 day relative strength, and it is approaching overbought levels at 35, not overly concerned but cautious now. Unlikely any selling in the 10 or MBS markets in the next week will change the wider bullish outlook; HOWEVER there is a limit as to how low rates can fall now, and we confess we don’t know what that level is. The driver for the rate markets is, and has been, the recent selling in equity markets as investors and traders balance portfolios with an increase in treasuries. On days when stocks improve expect prices for MBSs to fall. We noted a week ago there would be an increase in interday volatility, that was the case last week and we expect the volatility to continue this week. Floating now is the proper thing but be prepared for wide swings. We would need a close above 2.79% on the 10 to change the bullish outlook (currently 2.67%); MBS prices would need to decline 112 basis points on the 4.0 coupon to change the MBS outlook. A very wide range for both markets.
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