The bond market had some very good gains in mid-day trading. At one point the rate was as low as 4.541%. Some of the gains were given up in late trading as the 10-year Treasury closed at 4.553%.

Although the T-Budget had a greater deficit than expected (-$120b), it did not seem to impact rates. If it had affected rates a deficit that was greater than expected would have caused rates to go up. But, rates remained stable at the T-Budget’s release.

TODAY, 13 March 2007

Rates on Treasuries are down again this morning. There are two reasons for this. There is still concern about the subprime mortgage industry, and Retail Sales were below expectation.

There is speculation among bond traders that home-loan delinquencies among the riskiest borrowers will hamper economic growth.

Accredited Home Lenders Holding Co., a subprime, is looking for debt waivers and may go into bankruptcy. It is also going to try to raise new funds.

According to Bloomberg’s: “The prospect of bankruptcies in the U.S. mortgage industry prompted investors to buy the safest assets. Treasuries extended gains after data showed less-than-forecast retail sales.

``There's a lot of anxiety across the globe among investors about a significant housing slowdown and the related effect on the economy,'' said Mustafa Chowdhury, head of interest-rate research in New York at Deutsche Bank AG. ``That anxiety is feeding the flight-to-quality trade.

Retail Sales for February were lower than what analysts were projecting. Most of the groups we follow were expecting total Retail Sales to be +0.2% to +0.4%. One group was closer with a guess of +0.0%. The actual number reported by the Commerce Department was +0.1%. This is higher than last month’s +0.0%

The more important core-Retail Sales number excludes the volatile auto sales. Economists were predicting a number of +0.1% to +0.4%, but the actual core-Retail Sales number was -0.1%. This is in contrast to last months +0.3%

Retail Sales, and concern about the subprime mortgage industry have impacted rates in a good way. The 10-year Treasury is -.041% with the rate at 4.512%.

TOMORROW, 14 March 2007

Wednesday sees the release of the important Import Prices and the attached Export Prices. Import Prices are predicted at +0.8% to +1.0%.

Export Prices have no predictions and are not viewed as important by the bond market.

The other important item at the market’s opening is the 4^th Quarter Current Account. Bloomberg.com defines it best; “The current account measures the United States' international trade balance in goods, services, and unilateral transfers on a quarterly basis. The levels of exports, imports and the current account indicate trends in foreign trade.” Forecasts for the Current Account range from -$203.0b to -$204.0b.

The market also opens with the release of MBA Purchase (& refinance) Index. There is no prediction for this, but it does give clues as to the future of the housing market.

The quarterly Services Survey will also be released at the opening. It is a very new item and has little track record. As a result, it has no predictions, and is mostly ignored by the bond market.

We are neutral on locking V floating.

[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.]

MID-TERM OUTLOOK [12 March 2007]

Rates have been pretty good as we enter the last month of the 1^st 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 the 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 next 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 trading in the last three weeks. It is apparent that bond investors are still of the mind that inflation is whipped, and-or the economy is slowing.

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 in February, “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 (IN JAN) 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 – do not seem to have caused concern on Wall Street; at least not yet. 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.

Steve Boxmeyer [612] 799 – 6858
steve@LendWithIntegrity.com