Risks favor: Floating into Bernanke Testimony

Current Price of FNMA 5.5% Bond: $98.97, +16bp

Mortgage Bonds popped a bit higher on a weaker than expected Durable Goods Report for January. The typically volatile indicator showed a -5.3% reading, below expectations of -4.0%. Adding further weakness was a downward revision to the prior month’s reading from 5.2% to 4.4%.

New Home Sales will be reported at 10am ET and it could possibly be a market mover. However, the financial markets are now bracing themselves for Fed Chairman Ben Bernanke, who will deliver his semi-annual monetary policy testimony before Congress. Bernanke will speak to the House Financial Services Committee at 10:00am ET and before the Senate at the same time tomorrow. All eyes and ears will be on Mr. Bernanke as he discusses the economy, inflation, and a plunging US Dollar that has just set record lows against the Euro and other rival currencies. A weaker Dollar results in higher commodity prices that could eventually lead to higher inflation.

Big Ben may attempt to paint a bit of a rosy picture in order to justify the barrage of Fed cuts we have seen of late. As you know, bond prices have reacted negatively to the cuts as bond investors fear the inflation that will erode the fixed return they receive, due to the stimulated economy from the cuts. Remember that it often takes 6 – 9 months for a Fed action to filter its way through the markets and have an effect on economic conditions. The first in the latest series of cuts was only 5 months ago, so we may have yet to see the impact of any of the 225bp worth of cuts. Additionally, the President’s stimulus package will add to the mix.

Speaking of inflation, the Wall Street Journal has a headline today saying that inflation could be a bigger problem than many think. It looks like they are starting to whistle our tune as we wrote this verbatim within our forecast for 2008. Nice to see them reading our material.

Technically, Mortgage Bonds are looking a little prettier after successfully bouncing higher off of the 200-day Moving Average yesterday. But the positive signs could sour quickly should Bernanke surprise the markets, although as we mentioned earlier – he may be more dovish in his comments. For now we will continue to float and see if Big Ben does indeed help prices improve – but we will be ready to lock in this rapidly changing, volatile environment.