The bond market is very nice to rates this morning even though the only economic item of the day will not be published until 13:00cst. The 10-year Treasury is -.048% with the yield at 4.547%. That is not too far from the low today which was 4.539%.
Bonds appear to be reacting to two items. The open saw some drop due to bond traders concern of the mortgage industries worries with Subprime Lending. Subprime mortgages are for those borrowers that have ‘bruised’ to ‘very bruised’ credit. New Century Financial., the second biggest Subprime mortgage lender said that its creditors claim that it is in default. Other subprime lenders are closing the doors or have closed doors. Freemont abruptly did so last week, not even honoring approved loans. Countrywide Financial, the nation’s largest lender, though not the largest subprime lender has seen problems with its share price in the last few weeks.
This causes the bond market (and stock market) to believe we could be headed for a slower economy. Bad for the economy = good for rates.
We are attributing a further drop in rates to an article on Bloomberg.com. They reported on Alan Greenspan’s comments. According to Bloomberg’s Daniel Kruger, “Alan Greenspan, who jolted investors by predicting a one-in-three chance of a recession this year, isn't as bearish as the bond market, where the risk of a downturn is even money.
The probability the U.S. economy will shrink for two quarters has risen to 50 percent, according to a model created when Greenspan ran the Board of Governors of the Federal Reserve System. The formula is based on differences in yields on Treasuries. The economy has gone into recession six of the seven times since 1960 that short-term interest rates topped longer-term bond yields, as they do now. The difference between three-month bills and benchmark 10-year notes is close to the widest since 2001. Investors say the so-called inverted yield curve is a sign the Fed will cut borrowing costs because the economy is decelerating.
``We're going to have slower growth,'' said Barr Segal, a managing director at TCW Group Inc., a Los Angeles-based firm that oversees $80 billion in fixed-income assets. ``The fundamentals of the economy are what you have to watch.''
The 10year Treasury dropped about -.015% when this item was published.
We will not see the publication of the Treasury Budget until 13:00cdt {18:00gmt}. It is anticipated to be a -$118.0b to -$123.0b deficit. Last month was -$119.2b. This could influence rates if it is reported outside of that range. Unfortunately, we have no guess if it will, or which way if it does. Lock this morning while rates is good.
TOMORROW, 13 March 2007
Retail Sales are out at the open and have a habit of affecting rates. Aggregate Retail Sales are expected to be higher than last month’s growth of 0.0%. Analysts are looking for a growth of +0.2% to +0.4%.
The more important part of this report is the Retail Sales less Auto. Predictions range from +0.1% to +0.4% which straddle last month’s report of +0.3%. We lean to the lower growth numbers which could be good for rates.
Business Inventories are also looking to be higher than the last month’s report of 0.0%. They come out at 09:00cdt {14:00gmt} and are forecast at +0.1% to +0.3%.
While we see some chance for even better rates tomorrow, we see the risk for higher rates greater given today’s price increases. (Rates and price always move in opposite directions.) There is a good chance traders will take profits tomorrow. Best advice is to take the safe route today and lock.
[Publisher’s note: With the exception of Saturday & Wednesday, we will publish only one of the outlook sections each day on a rotating basis, none on Friday. SHORT-TERM OUTLOOK (on Monday) attempts to forecast and discuss up to the next 30 days. MID-TERM OUTLOOK (on Tuesday) looks forward from 15 to 90 days, most often 30 to 90 days. The Mid-term has the most accurate predictions, just like the weather. The LONG-TERM OUTLOOK (on Thursday) will extend out the next six months, maybe one year. When we change an outlook section we will embolden the date and heading.]
SHORT-TERM OUTLOOK [12 March 2007]
Rates have been good the last few weeks, at least in part due to a flight to safety. One very important thing to consider, flights to safety are almost always temporary. Once things settle down, and the equity markets stabilize, the cash will flow back out of bonds and rates will go back up. We recommend locking today.
This week’s economic data will keep us very busy as we are loaded with important and very important items. Only Monday and Wednesday have moderately important items; Treasury Budget, and Import Prices respectively. Tuesday holds the Retail Sales, and Business Inventories. Thursday is a heavy day with Producer Price Index (PPI) and both the NY Empire Index, and the Philadelphia FED Index. Friday probably wins the award for the heaviest day, but only by a nose. IT contains the Consumer Price Index (CPI), the Production Report, and Mich. Consumer Sentiment – prelim.
The biggest numbers of the week are the PPI & CPI numbers. The record has been mixed of late as to which way they sway rates, but the record has not been mixed in that they have impacted rates.
MID-TERM OUTLOOK [12 March 2007]
Rates were pretty good as we enter the last month of the 1st Quarter. But we need to caution that they may not drop much further. That is, unless the 10-year Treasury goes below the 4.500% level for more than 5 trading sessions. That is our next “psychological floor”. The market has toyed with going below that level, but never for more than a few trading sessions.
We are not as optimistic on rates for the remainder of the 2nd quarter. As homeowners start to see a rebound in housing their confidence will increase. As confidence increases, so will spending. That will bring back inflationary fears.
The good news is the bond market’s reaction to the Treasury Auctions of the week of 05 to 09 February and the last three weeks. In each case there was heavy demand, especially for the longer term bonds. It is apparent that bond investors are still of the mind that inflation is whipped, and-or the economy is slowing. They may be right on the first issue, but probably not on the second.
The majority of economists seem to see the FED on hold for the next few months. That could be good given that the bond market has a desire to keep long term rates below the FED-Funds rates.
Stephen Stanley, RBS Greenwich Capital was quoted in the Wall Street Journal, “The tweaks at the margin argue for less risk of a move in either direction. So the Fed is on hold for a while with a slight lean toward hiking, whereas the market has the Fed on hold for most of the year with a slight lean toward an ease late in the year.”
But there is still some concern for inflation. Bear Stearns Economics said, “If GDP growth continues above 3%, as we expect, and if core inflation pressures show any sign of creeping higher, this statement leaves the Fed flexibly positioned to raise rates before the middle of the year. If January data on employment and retail sales suggest that the economy continued at an above-trend pace, then Bernanke could adopt a more hawkish tone on Feb. 14 (when he delivers his semiannual testimony on monetary policy and the economy to Congress). Our expectations for the Fed's central tendency forecasts for 2007 are 2¾% to 3% on real GDP growth and 2% to 2¼% on core PCE price inflation.”
Regardless of what the FED does within its FOMC, the bond market will react to changes in inflation and economic growth. Joshua Shapiro, of MFR Inc. has an interesting theory, “Our own view is that unusually warm weather has played a role in boosting activity…data will cool off as weather patterns (presumably) normalize. However, until this is borne out in the data, the Fed and markets will remain concerned about the effect that an upside growth surprise could have on inflation pressures.” The weather should bear watching.
It is our own view that the economy can still grow without impacting inflation. Energy costs – while still high – seem to have abated some. Wages have grown – except at the lower end of the income scale. That has a way of keeping the lid on the wage-price spiral.
We have one great inflation fear in the mid-term; corn prices. With all the talk of alternate fuel and ethanol, corn futures have nearly doubled. That will impact not just corn flakes, but pop/soda, beef, and pig, just about anything we eat.
Commentary: Let’s eat food and burn oil.
LONG-TERM OUTLOOK
In the long-term, we may see some easing in the FED funds rates in late 2007.
Most economists tend to agree with Richard F. Moody of Mission Residential as do we. “We (Mission Residential) continue to hold to our view that no changes in the Fed funds rate are on tap for the first half of 2007 before what we expect to be below-trend GDP growth will open the door for two rate cuts over 2007's second half, but are increasingly open to the possibility that the FOMC could remain on hold for the remainder of 2007.”
The good news is still in the employment and production fronts. Both will conspire against each other to keep inflation low.
Steve Boxmeyer [612] 799 – 6858
steveb@LendWithIntegrity.com