Risks Favor: Floating, but be ready to lock

Current Price of FNMA 6% Bond: $100.38, +9bp

Mortgage Bonds are trading slightly higher, but the ceiling of resistance at the $100.47 level has prevented prices from improving further so far. Stocks are under heavy selling pressure this morning after Goldman Sachs downgraded the entire US broker industry from attractive to neutral citing continued deterioration of the banking industry and the prospect of a lengthy recovery.

Yesterday, as expected, the Federal Reserve left rates unchanged at 2% after seven consecutive cuts that started in September and ended at the April 30th FOMC meeting. The forward looking statement read “in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high.” This phrase along with some others highlighted the Fed’s tough talk on inflation, but their lack of action initially pressured the Bond Market lower, before prices rebounded to finish the day just slightly lower. We feel strongly that the Fed has to step in and hike rates in order to strengthen the US Dollar and combat high Oil prices. In response to yesterday’s Fed pause, Oil is trading over $3.00 higher this morning and near the $138 level. With Oil prices this high and inflation threats looming, it is very tough to see Mortgage Bonds moving much higher from here.

The final Gross Domestic Product (GDP) was released today showing a 1.0% increase for the first quarter and was inline line with estimates. Initial Jobless Claims were 384,000, slightly higher than expectations of 375,000. The four-week average of those claims rose to 378,250, the highest since October 2005. Both figures are above levels signal continued weakness in the labor market.

Existing Home Sales for May were reported at 4.9 Million units, which was inline with expectations. The inventory of unsold existing homes dropped slightly to a 10.9 month supply. The report tells us the housing market is weak but stable.

Mortgage Bonds are now pressing up against Resistance at $100.46 with the next level of $100.79 seen at the 25-day Moving Average. We can cautiously float for now – but be ready to lock as there are some strong headwinds to contend with. First – Stocks are heavily oversold and with everyone having such a negative outlook on Stocks in general, contrarian thinking may mean a bottom in Stocks is near. A reversal higher in Stocks would likely hurt Bonds. Additionally, the Bond market will have to absorb a $20 Billion Five-Yr Note auction at 1pm ET and the added supply could weigh on the market overall. Finally, as mentioned, higher oil prices and overhead resistance could put a lid on any further price advance.