Market Update — One Man's Floor Is Another Man's Ceiling (5162014) LoanSafe's

Market Update — One Man's Floor Is Another Man's Ceiling (5/16/2014)

Erik Sandstrom Mortgage Expert — Call 1-800-779-4547

Position trading continues to drive yields lower. The 10yr dropped from 2.66% on Monday all the way down to 2.47% on Thursday, before backing up a tad to its current level of 2.51%. No major fundamental changes to the market or economy for that matter; in fact the data this week was rather supportive of higher yields. Speculation of lower yields in Europe are generating demand for US debt and the 2.55% 10yr floor was breached. The very tight trading range was broken and a new range is being developed. Many are calling the range 2.40-2.60%, while others believe 2.30% is now possible. Bond bears (those expecting higher yields) got crushed and were forced to cover their shorts with heavy losses. Asia has been on the sidelines for the most part and domestic buyers who wouldn’t take a 2.60% 10yr are now forced to own bonds at 2.50%. In general lower yields shorten the duration of a portfolio and force portfolio managers to buy more. It’s the forced buying on top of lower yields that breaks ranges. Buying begets buying. Selling also begets selling. It appears as if the 100bps increase in yields last year was too extreme and bond bears were the big cause. Now they are getting their backside handed to them and the giant pendulum is swinging the other way.

The economic data this week showed Retail sales to be rather weak in April, but inflation was moving higher. Jobless claims were better than expected as was housing starts and the Phili Fed business outlook. Consumer confidence did decline and is causing a small backup today. Inflation is supposed to be a good indicator of economic growth but when it’s food and gas prices, that’s going to affect the mind of the consumer. But who really cares about the economic data, it’s all marginal good and bad at this point. The market is being driven by buyers and sellers. The Fed is moving further and further into the backseat; now will the real level of interest rates please stand up! That’s the million dollar question, what should the level of interest rates be? We get lost in the Fed this and the data that. Don’t get me wrong the benchmark Fed Funds Rate is the main driver of interest rates but when the Fed says they will provide some level of accommodation for a considerable period of time, that’s like yelling ‘recess!’ to a room full of elementary school kids. They’re in charge now.

It doesn’t appear rates are headed back up into the 2.60’s without some seriously positive economic news (and it has to be material) or a major shift of verbiage from the Fed. I do believe 2.30% is now back on the table given we’ve pushed down to 2.47% this week. The last time the market closed at 2.47% was July of last year. If we break through 2.45% then 2.30% will come quickly. The market is at the edge of the cliff and nobody knows how far down the ground is; fear could gain momentum. The Fed talks out of both sides of their mouth so you hear positive economic trends out of one side and accommodative for a considerable period out of the other side. They are afraid of what could happen and we are getting very close to that fear: the panic buying for yield. I mean, can you make an argument to buy stocks at these levels. Mortgage production has been so low there isn’t much left to buy. The scramble for return is on. I still maintain yield chasers are going to lower yields and widen the credit box. That is the only relief to the pressure that has been building. Cheap money for years and years will do that. It creates an economy that relies on continued cheap money and tons of assets to buy. Get rid of most of those assets and the machine must feed on something else.

What’s going to happen? Hard to say but it’s probably 60/40 that we head to lower yields before moving to higher yields. Let’s see how many days we can close below 2.50% first.

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