Risks favor: Cautiously Floating Ahead of Fed Rate Decision

Current Price of FNMA 6.0% Bond: $100.88, -9bp

Today is Fed day. At 2:15pm ET, the Fed will release it’s monetary policy decision and statement.

Meantime, Bond prices are trading a little lower on some hotter than expected economic news.

Third quarter GDP was reported at a beefy 3.9% annual growth rate in the face of one of the worst housing slumps in decades - this is good news for the economy, but bad news for Bonds. The increase caught economists by surprise as their consensus estimate called for a 3.1% growth rate. It appears to us that the softer Dollar has added quite a boost to the economy because our goods and services are more attractive to foreigners. Additionally, US residents may shy away from purchasing foreign goods because they require more Dollars to obtain them.

Also applying a little selling pressure to Bonds is a stronger than expected ADP report, which showed 106,000 private sector jobs created in October. After adding a three month average of 23,000 new government jobs, the ADP Report predicts a total of 129,000 new jobs for October, a significantly greater number than the current consensus estimate of 80,000 new jobs. ADP has been more accurate of late as a tool to forecast the official Jobs number. Tomorrow, we will be laying out our Jobs Report strategy heading into Friday’s report.

Chicago Purchasing Managers Index (PMI) was reported at 49.7, which was less than expectations of 53.0. Readings above 50 indicate economic growth while those below 50 indicate contraction. Bonds had little reaction to this weaker than expected report.

This morning's strong GDP did catch the market by surprise and many are saying the Fed will not cut rates this afternoon. We disagree and believe the Fed will cut rates by .25% today. It will be important to hear what the Fed has to say in their statement.

For now, we will cautiously float as the Bond trades just above a floor of support heading into today’s important announcement.

The Federal Open Market Committee adjourns from its two-day meeting this afternoon and is widely expected to lower the Fed Funds Rate. This does not mean that mortgage rates are being lowered, too.

The definition of Fed Funds Rate from the Federal Reserve:

The federal funds rate is the rate charged by one depository institution on an overnight sale of immediately available funds (balances at the Federal Reserve) to another depository institution; the rate may vary from depository institution to depository institution and from day to day. The target federal funds rate is set by the Federal Open Market Committee (FOMC).

Notice that the words “consumer” and “mortgage” are nowhere to be found. That’s because the Fed has nothing to do with them.

The Fed does not control mortgage rates.

The Federal Reserve’s policy changes impact banks, which then impacts consumers in the form of “looser” or “tighter” credit standards.

In lowering the Fed Funds Rate, the Federal Reserve stimulates the economy. In raising the Fed Funds Rate, it slows the economy. The big risk, therefore, is lowering too much (which promotes inflation) or raising too much (which retards growth). It’s a difficult dance.

The FOMC will release its policy statement at 2:15 P.M. ET.

Source
FRB: FAQs: Monetary Policy
http://www.federalreserve.gov/generalinfo/faq/faqmpo.htm#3

When a loan officer locks a mortgage rate for you, that rate is tied to an expiration date.

The expiration may be 30 days, or 75 days, or 90 days, or more into the future, but so long as the rate is “locked”, the bank is committed to delivering that rate to you at your closing.

What most people don’t know is that the longer the rate lock, in general, the higher the interest rate and/or fees and that’s because banks can’t predict the future.

The more time that passes between today and your rate lock expiration, the more likely it is that market conditions will have changed from where they are today, and the bank will be “below market” on your individual loan.

Therefore, banks compensate for this “time risk” by increasing their rate of return (i.e. your mortgage rate), and/or charging “extended lock fees” to borrowers.

To lenders, rate locks represents a huge risk — what if its prediction of the future is wrong?

Rate locks vary from lender to lender, but in general, they move in 15-day increments — 15-day, 30-day, 45-day, et cetera. After 90-days, rate locks tend to move in 30-day increments. The shorter the time, generally, the lower the rate and/or fees.

So, when you’re negotiating a new contract on a home, it makes more sense set a closing date 30 days in the future as opposed to 40 days; 45 days as opposed to 46. By keeping your rate lock commitment days as low as possible, you’ll help save money long-term.

There’s no sense in paying for extra rate lock days if you don’t need them.

Strong earnings from Apple, American Express, Microsoft and Boeing helped to keep markets in balance last week after reports of weak business spending and poor housing data (again).

The available data doesn’t seem to match corporate earnings reports and that is giving investors fits.

Mortgage rates bounced around last week on the lack of conviction from the markets.

The uncertainty may be resolved this week, though, after several major events make their ways through trading circles.

The first major event is the Federal Open Market Committee’s two-day meeting, beginning October 30-31.

The FOMC meets eight times annually and, at its last meeting, the FOMC voted to lower the Fed Funds Rate by 0.500% to 4.750%. When this happened, mortgage rates briefly dipped, and then soared.

As of today, markets are predicting another decrease, but are unsure of how large the decrease will be. If you are currently floating your mortgage rate, or shopping for a mortgage, you’ll likely have much different pricing prior to the Fed’s meeting than after it so be aware.

Then, on Thursday, the next major event hits: the Personal Consumption Expenditures. This is the Fed’s preferred inflationary gauge and PCE is expected to show a 1.7% increase. If the number comes in hotter than expected, though, the dollar should weaken on inflation concerns, thereby causing mortgage rates to rise.

And, lastly, on Friday we’ll get October’s employment report.

It’s expected that the economy added 90,000 jobs in October and that the unemployment rate held flat at 4.7%. Each month, this data point is a huge market mover because more working Americans means that more Americans can afford to consume goods. More consumption pushes the economy forward so as we head into the Holiday Shopping season, the employment data should impact Retail Sales for October, November and December.

It’s a busy week, everyone, and mortgage rates could be very different from day-to-day. If your rate looks good today, perhaps you should consider locking it.

Risks favor: Cautiously Floating as Bonds rest on support

Current Price of FNMA 6.0% Bond: $100.88, -12bp

Stocks are trading higher, led by strength in Countrywide and Microsoft, and the flow of money into Stocks is coming by way of Bonds being sold. This has pressured Mortgage Bonds lower and down to support at the $100.84 level. Countrywide did report poor earnings, but not as bad as “the street” was expecting. They also provided some optimism for the future. At 12 Noon ET today, Countrywide will be holding a conference call for analysts, so the markets will hear more about what Countrywide sees for the future – and this will be especially interesting for us in the industry to hear Countrywide’s outlook for the mortgage business in general.

The University of Michigan's Consumer Sentiment Index for October was reported at 80.9, which was less than expectations of 82.3. The Fed watches this index as a determining factor in monetary policy

. Mortgage Bonds improved slightly on the weaker than expected news.

Technically, Mortgage Bonds are showing signs of topping out at long-term resistance after reaching a level of previous market peaks over the past couple of days. But for the moment, prices are attempting to hold at support at the $100.84 level. Should Stocks continue to move higher, it may wear on Bonds and push them beneath this support.

Looking ahead, we are expecting a Fed rate cut next Wednesday. Like we saw last month as well as many times in the past, a Fed rate cut initially helped Bonds, but they were eventually pushed lower. We would like to be patient and float until the Fed Meeting next Wednesday, but should prices drift any lower, we will quickly switch to a locking stance and preserve the recent gains.

The Federal Open Market Committee is widely expected to lower the Fed Funds Rate next week.

For holders of credit cards and home equity lines of credit, this is good news.

Both of these financial products feature interest rates tied to Prime Rate. Prime Rate is tied to the Fed Funds Rate.

When the Fed Funds Rate comes down, therefore, so does the rate of borrowing for credit cards and HELOCs.

For mortgage rate shoppers, a drop in the FFR could be bad news.

When the Fed lowers the Fed Funds Rate, it signals that the U.S. economy is weakening and that tends to weaken the U.S. dollar. When the dollar weakens, the value of dollar-denominated securities weaken, too.

Mortgage bonds are denominated in dollars, of course, so when the dollar loses value, mortgage bonds lose value as well. This causes mortgage rates to move higher.

After the Fed’s last meeting, it lowered the Fed Funds Rate by 0.500% and, predictably, mortgage rates headed higher in response.

According to Bloomberg, as of this morning, market players are predicting with 90 percent certainty that the Fed will lower the Fed Funds Rate by at least a quarter. That means that the currently low level for mortgage rates may not last much longer.

Risks favor: Cautiously Floating

Current Price of FNMA 6.0% Bond: $101.12, +6bp

Bonds are trading slightly higher on some weaker than expected economic news this morning.

Durable Goods Orders for September were reported at -1.7%, which was lower than expectations of a 1.5% gain. Additionally, August Durable Goods Orders were revised lower to -5.3% from the originally reported -4.9%. The only bright spot for the report was after excluding transportation orders, Durable Goods recorded a slight increase.

Initial Jobless Claims were reported at 331,000, which was worse than expectations of 320,000 claims. Also, the previous week's number was revised higher to 339,000, from a previously reported 337,000.

New Home Sales for September

will be reported at 10:00am ET. Unless the report wildly misses expectations, it shouldn’t be a market mover. Yesterday’s weak Existing Sales report has Traders already prepared for a soft reading in the New Home Sales report.

At 1pm ET, the US Treasury is going to auction off $13 Billion in Five-year Notes. The additional supply could weigh on the market if the auction isn’t well received by investors - especially foreign investors.

Yesterday’s auction of Two-year Notes showed decent results and had little impact on prices.

Technically, Bonds are at a high water mark – at least for 2007. The FNMA 30-year 6% Coupon hasn’t closed higher than present levels since December 2006. We want to be patient and see if Bonds can break above close resistance, but after gaining over 120bp in just 9 trading days, we also want to protect these gains. So we will continue to float and enjoy the better pricing, but will have a finger close to the lock trigger should prices show signs of reversing lower.

The Wall Street Journal used a lot of ink this morning on September’s Existing Home Sales data, including the chart below. It’s frightening to the lay person who may not know how to interpret data like this.

Remember: real estate is local.

Yes, on a national level the number of homes for sale in increasing and the housing market is showing weakness, but on a local level, the story is always different.

And, despite chunking the national data into 28 “Major Markets”, the figures below still can’t be considered “local”. The Miami-Fort Lauderdale market, for example, is a 31.6 mile tract of land.

Real estate markets vary by neighborhood and even by street. It’s why one zip code may be hot, and a neighboring zip code may be flat. It’s also why we should ignore national real estate price patterns and focus on the local trend instead.

Risks favor: Floating

Current Price of FNMA 6.0% Bond: $100.97, +16bp

Bond prices “gapped open”, or opened higher than yesterday’s close, as Stocks are under some selling pressure this morning.

Merrill Lynch, the country's largest investment banker and broker, reported a far more massive 3^rd quarter earnings loss than was expected. Just a few weeks ago, Merrill estimated they would have to 'write down' or revalue about $5 billion in the value of complex financial instruments known as collateralized debt obligations (CDOs) containing underperforming sub-prime mortgages. Now the company says it wrote down $7.9 billion worth of CDOs and related sub-prime mortgage securities. Merrill also reported a whopping 94% loss in revenue earning $577 million. The entire Stock market is trading lower on this news, and this is helping Bond prices improve.

Existing Home Sales for September came in pretty ugly, underscoring the problems created by a tightening mortgage market. U

nsold inventory spiked to a whopping 10 1/2 month supply, and the median home price dropped by 4.2% year over year to $211,000. The biggest problem areas were California and Florida – which stands to reason, as they also enjoyed some of the largest gains in recent years. Much like the last housing decline in the early 90′s, a recovery will likely be measured in years, not months.

At 1pm ET, the US Treasury is going to auction $20 Billion in Two-year Notes. It will be interesting to see how well the auction is received by domestic and foreign investors. With the chances of a Fed Funds Rate cut next week looking good, today’s auction should go off pretty well as investors try to lock in higher yields ahead of the Fed’s move – and a successful auction should support Bond prices this afternoon.

Each day our thoughts and prayers go out to our family of subscribers that have been affected by the fires in California.

Bonds are now hovering near the best levels of 2007. This morning’s gap higher shows continued buying pressure and this is a positive for Bonds. Our move to a Floating stance since hitting support on the 50-day Moving Average has now resulted in a gain of 105bps.

The number of home valuation Web sites continues to grow.

A simple Google search for “How much is my home worth?” shows 119,000 results and seems to get larger month-over-month.

For home sellers, these programs can give a false sense of security (or insecurity!) about at what price a home should be listed for sale.

Computer programs can never replace the role of licensed home appraisers and that’s because valuing a home is not as simple as providing some inputs (traits) in order to get some output (value). There is a “fuzzy logic” that computer programs just can’t produce in the same way that appraisers and real estate agents can.

Even with tax records, recent sales data, and a full description of a property, valuing a home is as much “art” as “science”.

There are “human” considerations that include neighborhood quality and curb appeal that a computer can’t measure. Nor can a program take into account how a kitchen may require $20,000 worth of work to bring it “up-to-date” or inline with neighbors’ homes.

Besides, the real value of a home is what somebody is willing to pay for it. Therefore, you can never truly know what a home is worth until it has sold.

So, while automated valuation tools are a good start to finding a home’s value, they’re not equipped to finish the job.