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. Unsold 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.