The bond market’s reaction is seldom a response to the FED’s rate change.  Today will most likely be that way.  But, when it does react to the rate decision the move is very dramatic. Most often the rate move is in response to the summary of the minutes. FED watchers try to gauge the future of the FOMC’s actions. One can almost time the reading speed of the average analyst. As they read through bearish and bullish comments the bond market moves in a corresponding direction.

There was good news for the Real Estate industry in the morning. The MBA Purchase Application Index has shown some improvement in the last two weeks. The four week moving average has increased in the last four weeks. This morning’s weekly number was 410.6. The 4-week moving average was 407.58, last week was 399.65.

The 10-year Treasury is +.036% with the rate at 4.581% and has traded at that level all morning. 

TOMORROW, 22 March 2007

The data out is of moderately high importance, and we have a small chance of volatility.

The market opens with the release of the weekly Initial Jobless Claims. This is the heaviest of the weekly items and can move rates. It is predicted to be higher than last week with economists thinking that it will be 320k to 325k. This is an inverse indicator; a higher than expected number is good for rates. We are not certain that that will be the case. This has come in lower in the last few weeks and could happen tomorrow. This could cause rates to increase tomorrow.

At 09:00cdt {14:00gmt} the Conference Board publishes the Leading Economic Indicators. Predictions are lower than last month’s +0.1%, at -0.3% to -0.6%. The LEI can move rates on occasion.

[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.

LONG-TERM OUTLOOK [31 January 2007]

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

steve@LendWithIntegrity.com