Market Comment

Mortgage bond prices rose last week pushing mortgage interest rates lower.  The US dollar continued to strengthen.  Oil remained volatile and initially improved from the strengthened dollar.  Unfortunately oil prices pushed higher the end of the week, which reignited inflation fears as Gustav threatened the Gulf of Mexico.  Fears of refinery disruptions increased.

The Preliminary 2nd Quarter reading for Gross Domestic Product (GDP) was revised higher to 3.3%, far exceeding expectations of 2.7% and was much more than the 1.9% that was previously reported.  Next month we will see the Final reading for the 2nd Quarter GDP - but for now, this number is surprisingly strong and has boosted Stocks while pressuring Bonds lower.

Initial Jobless Claims were reported at 425,000, in line with expectations and the markets had little reaction.  Oil prices have climbed back above $120 a barrel as Hurricane Gustav continues to makes its way towards the Gulf of Mexico's oil and gas platforms. 

At 1pm ET, Bonds have another round of supply hitting the market by way of $22 Billion in 5-year Treasury Notes.  Yesterday's 2-year Note auction had so-so results, but today's Five-year may be more closely followed, so stay tuned.

Bonds have enjoyed a nice little rally after bouncing off of the 50-day Moving Average.  We can continue to carefully float, but don't stray too far from the lock trigger - prices are now testing a tough ceiling of resistance at the 100-day MA and are already off the best levels of the day.  Even if prices do break above this ceiling, the Bond will have it's work cut out to break above the 200-day Moving Average, just 49bp above current levels. 

Market Comment

Mortgage bond prices rose last week pushing mortgage interest rates lower.  Stronger than expected producer price index data was overlooked as oil prices remained lower the beginning of the week which eased inflation fears.  Unfortunately oil prices spiked higher towards the end of the week with a $6/barrel swing on Thursday alone.  Traders were concerned about international political tensions with Russia.

For the week, interest rates on government and conventional loans fell by about 1/8 of a discount point.

The preliminary gross domestic product data Thursday will be the most important event this week.  The bond market closes early Friday in advance of the Labor Day Holiday.  The shortened trading week may lead to market volatility.   

Economic Indicator	Release Date and Time	Consensus Estimate	Analysis
Existing Home Sales	Monday, Aug. 25, 10:00 am, et	Up 0.8%	Low importance.  An indication of mortgage credit demand.  Significant weakness may lead to lower rates.
Consumer Confidence	Tuesday, Aug. 26, 10:00 am, et	53.0	Important.  An indication of consumers’ willingness to spend.  Weakness may lead to lower mortgage rates.
New Home Sales	Tuesday, Aug. 26, 10:00 am, et	Down 1.3%	Important.  An indication of economic strength and credit demand.  Weakness may lead to lower rates.
Fed Minutes	Tuesday, Aug. 26, 2:00 pm, et	None	Important.  Details of the last Fed meeting will be thoroughly analyzed.
Durable Goods Orders	Wednesday, Aug. 27, 8:30 am, et	Up 0.1%	Important.  An indication of the demand for “big ticket” items.  Weakness may lead to lower rates.
Preliminary Q2 GDP	Thursday, Aug. 28, 8:30 am, et	Up 2.7%	Very important.  The aggregate measure of US economic production.  Weakness may lead to lower rates.
Personal Income and Outlays	Friday, Aug. 29, 8:30 am, et	Income down 0.1%, Outlays up 0.3%	Important.  A measure of consumers’ ability to spend.  Weakness may lead to lower mortgage rates.
U of Michigan Consumer Sentiment	Friday, Aug. 29, 10:00 am, et	62.3	Important.  An indication of consumers’ willingness to spend.  Weakness may lead to lower mortgage rates.

Fed Minutes

The Federal Open Market Committee decided in December of 2004 to reduce the lag time between the open market committee meeting and the release of the minutes from six to eight weeks to only three weeks.  The minutes from the meeting have the ability to cause mortgage interest rate volatility because they provide more policy details than the standard post meeting release.  Most importantly the minutes provide the Fed’s complete economic analysis and the various opinions of individual Fed members.  There is typically an overwhelming consensus among the members.  However, there can also be dissension, which often causes uneasiness in the financial markets.  The release often comes and goes without much uproar but keep in mind that if any of the text seems troubling to analysts you can see market volatility.

Remember that mortgage interest rates remaining historically favorable.  Capitalizing on current levels is wise amid the recent geopolitical instability across the globe.  Inflation fears could be stoked if Russia reduces the flow of oil in Eastern Europe.  Inflation, real or perceived, generally does not bode well for mortgage bonds and could cause rates to rise.

Rate cuts, and new loans

The Fed has slashed interest rates over the past year to 2% from 5.25%, but that's the least of what they've done. In addition to traditional rate cuts, the Fed has instituted several innovative emergency loan programs to provide liquidity to commercial and investment banks.

The Fed has now moved to the sidelines - unwilling to move rates lower due to the threat of inflation and having promised to keep lending cash to financial institutions until at least the New Year.

My guess is that the programs will need to be in place longer to prop up the skittish mortage market.  The recovery to the financial institutions will not happen in the next 4 months. 

Despite this frenzy of action, there is no end in sight for the financial market turmoil and the related housing market downturn, many experts say.

"I have a feeling that it is far from over," said Barry Eichengreen, an economic historian at the University of California at Berkeley. Eichengreen and other experts see mounting credit woes for banks from credit cards and other consumer loans.

I think this is a big issue in front of us.  If consumers do continue to grow their credit card debt and with the resets on interest rates in place with the credit card companies now surprises are ahead of us.  What I mean is if you miss even one payment date your interest can skyrocket on not just that account but all of your accounts.  Be aware of the interest rate resets!

"I think there will be another wave of mortgage-related problems, emanating not from the subprime part of the market anymore, but from people with slightly more normal credit and mortgages," he said. "It is entirely plausible that there will be some hedge fund failures and commercial bank problems."

"I think this is going to bubble along for a while now," he said.

Former IMF chief economist Ken Rogoff reportedly told an audience in Singapore earlier this week that a large U.S. bank was likely to collapse in the new few months.

Since the beginning of the year, financial markets have reeled from one crisis to the other and remain very fragile. "You don't have the resilience now to shake off bad news," said Phillips, now dean of the business school at George Washington University.

Fannie, Freddie

The current crisis surrounds the worsening conditions of Fannie Mae (FNM) and Freddie Mac (FRE) , with many expecting a government bailout of the two mortgage giants.

To be fair, the economy has navigated the top part of the mountain in pretty good shape.

"I don't mean to sound like Phil Gramm...but there has been a huge amount of financial market disruption and the actual impact on the real economy has been limited," said Adam Posen, deputy director of the Peterson Institute for International Economics.

Gramm, a former senator, quit as a top economic adviser to Republican presidential candidate John McCain, after he said Americans were "whining" about the economy.

So far this year, there hasn't been a negative gross domestic product number.

And it is very easy to overstate the problems of the financial system, warned Minneapolis Fed Gov. Gary Stern in a television interview earlier this week.

But other economists are simply unsettled.

"It is not as if there are not some positive signs, but to me they are not consistent enough for me to be positive," said Phillips.

The fact remains that the first necessary condition for repair of the markets - the bottoming of the housing market - is not in sight. Until the housing market bottoms, it will not be clear how many losses the banks need to realize.

This statement you need to take city-by-city and actually neighborhoods within each city.  Many areas have bottomed out and are seeing price stability.

"Looking ahead, there is still substantial uncertainty about the ultimate realized magnitude of loss on mortgages in 2006 and 2007, said Richmond Fed President Jeffrey Lacker this week. "That uncertainty is out there - and that means still the potential for other shoes to drop."

"We are going to continue to see some at least moderate level of stress," said Lacker.

Robert Eisenbeis, a former researcher at the Atlanta Fed, said he is not confident that financial institutions have taken all the losses that they will.

Fundamental questions remain about the business of investment banking and commercial banks. "I don't think anybody knows yet how big and how viable a particular business is going to be," Eisenbeis said.

It has been a wild trading day so far.  Mortgage Bonds opened the day 12bp higher than yesterday's close, which suggests a lot of buying pressure at the beginning of trading.  However, prices have since turned lower, giving up all the early gains and more, as Traders take some profits from recent rise in Bonds.  The Bond is already well off the best levels of the day.

Initial Jobless Claims were reported at 432,000, which was basically inline with expectations.  The more closely watched four-week average of new state filings rose to 445,750, the highest since the recession of 2001.  The report, while looking bad, is being somewhat discounted as a new federal program continues to skew the new claims in recent weeks.

Oil is taking off today, now up close to $120 per barrel, after trading near $111 a barrel just a few days ago.  This is adding some selling pressure to both Stocks and Bonds.

The Philadelphia Fed Index was reported at -12.7, which was very close to expectations, and Leading Economic Indicators was reported at -0.7%, which was worse than expectations of -0.3%.  These reports did little to move the markets.

Even though Bonds are trading lower today, we have benefited from either an improvement re-price yesterday or better pricing this morning, thanks to yesterday's big rally.  But, going forward we have to be very cautious.  The recent rise in Bonds has pushed them into "overbought" territory, which makes them ripe for a reversal lower.  After yesterday's powerful move higher, Mortgage Bonds separated themselves from the 50-day MA.  But, this morning's wild reversal lower after the stronger open may lead to further price deterioration and another visit down to the 50-day MA, still 33bp below current levels.   Since the pricing losses happened before rate sheets were delivered, we can carefully float for now, but keep a close eye on the pricing windows on the Bond Page as the market is very, very volatile.

Of course I will be watching closely and will alert you if you need to take action.

 Usually when we see the stock market take a decline such as today with a 110 point decrease we will see a movement from investors into the Bond market.  When this happens it will usually improve mortgage rates.  However not today as the Bond Market can not seem to find enough support for improvement so far this week. 

WASHINGTON (MarketWatch) - U.S. retail sales dropped 0.1% in July, as falling auto sales offset an increase in gasoline sales sparked by higher prices, the Commerce Department estimated Wednesday.

Excluding the 2.4% decline in vehicle sales, seasonally adjusted retail sales rose 0.4% in July, the smallest gain since February. Excluding the 0.8% rise in gasoline sales, retail sales fell 0.2%.

"The consumer is running out of steam," wrote Nigel Gault, chief U.S. economist for Global Insight.

"The underlying trend in growth remains weak," said Scott Hoyt, an economist for Moody's Economy.com. "The lift from tax rebates began to fade" in July.

Retail sales are up 2.6% in the past year. The figures are not adjusted for price changes. Excluding gasoline, sales are up just 0.2% in the past year.

Sales were a bit stronger than anticipated, considering revisions. Economists surveyed by MarketWatch expected sales to fall 0.3% in July. Excluding autos, sales were expected to rise 0.5%.

Sales in June were revised higher to a 0.3% gain from the 0.1% originally estimated.

Retail sales, which account for about one-third of gross domestic product, are barely keeping pace with inflation over the past few months. The infusion of cash from the stimulus program passed by Congress to boost the economy has been offset to some extent by higher energy costs.

Gasoline prices began to fall in mid-July, so consumers may have a bit more discretionary spending money in August.

Still, many economists are forecasting that real (that is, inflation-adjusted) consumer spending will fall in the third and fourth quarters for the first time since the early 1990s. Consumers face four major headwinds: higher prices, flat growth in wages, tightening credit, and falling home and equity prices.

Some of the stimulus was spent on durable goods in July, the report showed. Sales at furniture stores rose 1%, the biggest gain in 18 months. Sales at electronics and appliance stores rose 0.8%. Sales at hardware and garden stores rose 0.3%.

The higher cost of gasoline was evident not only in the 0.8% rise in sales at gas stations, but also in the 1.1% increase at non-store retailers, such as catalogs and online stores.

Sales at the malls were soft in July. Sales at general merchandise stores rose 0.3%, including a 0.1% increase at department stores. Sales at clothing stores rose 0.2%.

Purely discretionary sales were weak. Sales at bars and restaurants fell 0.2%. Sales at stores catering to leisure-time pursuits and hobbies also fell 0.2%.

Sales at food stores rose 0.4%. Sales at health and personal care stores were flat.

In a separate report, the Labor Department said import prices rose 1.7% in July.

WASHINGTON (MarketWatch) -- The credit squeeze worsened in the past three months, the Federal Reserve reported Monday, and most banks expect to keep a lid on credit for the next year at least.

Despite all the aggressive moves by the Fed in the past year to ease the flow of credit to the economy, a record percentage of banks were making it more difficult for borrowers in the three months ending in July, the Fed said in its quarterly senior loan officer survey of 52 major banks.

A majority of banks tightened their rules for granting loans to businesses and consumers. The survey shows little appetite at banks to lend for home mortgages, credit cards, home equity loans, commercial real estate loans, or commercial and industrial loans.

No bank in the survey eased credit terms for any type of loan in the past three months, and only one bank said it anticipated easing standards for consumers in the next 12 months.

Tighter credit could slow economic growth, especially consumer spending, economists say. Lack of credit could sink the commercial real estate market, and curb capital investments by businesses. The survey is considered a leading indicator of credit creation in the United States.

"This is consistent with our view that consumer spending will slow markedly over the next several quarters," wrote economists for Lehman Bros.

"The impending tightening may ultimately curb consumer credit noticeably," wrote Harm Bandholz, an economist for UniCredit Markets. "This in turn would be another nail in the coffin of the U.S. consumer, who is already suffering from the weak labor market, high inflation and falling house prices."

Despite the tighter credit standards, however, other data from the Fed show consumers increased their borrowing on credit cards and auto loans through the end of the second quarter, perhaps because other sources of borrowing, such as home-equity loans and auto leases, are less available.

Banks told the Fed they were restricting credit because of worries about the economy, worries about risk or illiquid markets, and worries about their own fragile capital position.

Ninety-eight percent of the banks cited the uncertain economy, 92% cited illiquid secondary credit markets, and 75% cited reduced appetite for risk.

Banks were lowering credit lines, increasing interest-rate spreads, requiring more documentation, demanding more collateral, or requiring co-signers and or covenants before granting credit.

Consumers continued to be hit hard by tighter credit standards. A record 74% of banks said they had tightened standards for prime mortgages, usually given only to those with the best credit. A record 84% of banks said they tightened standards on nontraditional mortgages (also known as Alt-A), and a record 86% of banks that still make subprime mortgages said they had tightened those standards.

Businesses were also being squeezed. A record 65% of banks tightened standards for commercial and industrial loans to small customers. For commercial real estate loans, a record 81% tightened standards.

Details

C&I loans: Fifty-eight percent of banks tightened standards for commercial and industrial loans to large and medium firms, while 65% tightened for small firms.

Commercial real estate: Eighty-one percent tightened standards, while 50% said demand was weakening.

Residential mortgages: A record 74% of banks said they tightened standards for prime mortgages, while 53% said they saw reduced demand. For subprime mortgages, 86% tightened standards, with the number of banks who offer such loans declining to 14% of banks from about 30% two years ago. For nontraditional mortgages, 84% tightened standards while 63% reported reduced demand.

Consumer credit: A record 36% of banks reported less willingness to extend consumer installment loans; only 2% were more willing.

Eighty percent tightened standards on home-equity lines of credit.

For credit cards, 67% tightened standards, mostly by refusing new loans to consumers without good credit.