Friday’s Close

We saw some rate improvement on Friday afternoon. Investors continued to cover their position and the 10-year Treasury closed -.031% with the Yield at 5.132%.

TODAY 25 June 2007

Traders and investors are continuing to purchase bonds. The 10-year Treasury is -.031% with the rate at 5.102% in mid morning trading. There appears to be two driving factors.

A few weeks back rates moved up in response to foreign equity markets. It appears that the same foreign markets are going the other way today, helping our rates move lower.
Analysts are also crediting the sub-prime mortgage market for bond buying. Bloomberg reported, “U.S. Treasuries advanced as investors fled high-risk assets following losses at hedge funds betting on subprime mortgages.”

There was one major economic item this morning, the Existing Home Sales. Existing-home sales dipped during May to their lowest level in nearly four years, while inventories climbed and prices fell for a 10th straight time.

The National Association of Realtors reported Existing Home Sales fell to a 5.99 million annual rate. This was in the range of expectations which were from 5.85m to 6.0m units and did not move rats. April’s number was revises to 6.01million. This report was a 0.3% decrease from April's revised number.

The National Association of Realtors economist Lawrence Yun said that the fence sitting would-be buyers appear to be waiting for more signs of stability. "The market is underperforming when you consider positive fundamentals such as the strength of job creation, economic growth, favorable mortgage interest rates and flat home prices," Mr. Yun said.

The median home price was $223,700 in May, down 2.1% from $228,500 in May 2006. The median price in April this year was $219,800. The 2.1% drop marked the 10th consecutive year-over-year price decline.

The Dallas FED survey of economic activity in that region fell to 14 from last month’s 25.0. That was ignored by the bond market.

SHORT-TERM OUTLOOK [22 June 2007]

Next week will be busier than this one was. Every day contains some item that can impact interest rates.

Monday is one of the quietest days, but Existing Home Sales is out at 09:00cdt {14:00gmt}. It has impacted rates recently.

Consumer Confidence and New Home Sales are published on Tuesday

Wednesday is probably the quietest day as it only contains the Durable Goods Orders report.

The final 1quarter GDP report is released on Thursday.

There is one very important item on Thursday; the FOMC meeting. In all likelihood they will not change short-term rates. That does not mean that the

Finally, Friday has the Spending and Income numbers, as well as construction Spending, and Chi PMI.

We have seen some volatility of late as bond traders and investors attempt to find their footing. This amount of data will most likely give them reason to have to feel around even more.

MID-TERM OUTLOOK [18 June 2007]

There may be a few problems for rates this and next quarter.

1.) Investor sentiment leans towards higher rates. The bond market has been in a selling mood since 10 May 2007

A few months back this blog wrote that the bond market seemed to be looking for any excuse to buy bonds and thus drive rates lower. That trend has reversed itself. The bond market is now looking for any reason to sell, and correspondingly raise rates.

On 31 May 2007 there was one such example. There were six items published that day. Even though most of the economic items came in as expected, three did not. Of the three, two were lower than expected and should have moved rates lower. Instead rates continued their upward trend. Clearly, investor sentiment has turned bearish on buying bonds.

Investors are becoming bearish and are starting to realize that inflation exists. They are starting to see that the FED is more determined fight inflation. More and more FED officials are making hawkish comments.

2) The housing bubble has ‘burst’. Will housing continue to decline? Is it flattening? Or, is it on the verge of a rebound? The data over the last few months has been a resounding maybe to all three.

IF homeowners start to see a rebound in housing their confidence will increase. As confidence increases, so will spending. Economic growth is moderate now with problematic inflation. Strong growth could renew strong inflation.

The slide in Real estate has not yet seemed to affect retail sales or consumer confidence. Inflation hawks can’t win for losing.

On 08 May 2007 the bond market responded to an unscheduled announcement by the National Association of Realtors (NAR). The NAR reduced its sales forecasts for 2007 and 2008, predicting that stricter lending standards would limit home buying. That only makes sense as stricter guidelines reduce the number of buyers able to get a mortgage. Given the current oversupply of houses, verses the very number of buyers we have a buyers market now as it is. Reducing the number of buyers hits the real estate market with a double whammy.

Sales of existing homes will probably fall about 3% this year to 6.29 million from 6.48 million in 2006. Sales of new homes are projected to fall about 18% to 864,000, compared with a 14% drop predicted last month. Housing starts are expected to drop 19% to 1.46 million.

When there are signs of housing market weakness it helps the price of bonds. Since it is a sing of a slowing economy it instills safe-haven interest.

3) The US and the global economy appear to in recovery. This has to be the shortest, least felt ‘recession ever experienced. (The 2.2% main stream media aside, there never was a recession; GDP never went below 0.0 %.)

A major part of the growing global economy is China. On 12 June, the Chinese consumer price index for May was +3.4% in year-to-year analysis, according to data published by the [Chinese] National Bureau of Statistics. Most of the gains were due to food prices, and haven't spread to a broad range of consumer goods. What we would call Chinese core-CPI was +1.0%. China’s food prices jumped 8.3% from a year ago.

Even though Chinese core-CPI was low, the headline inflation rate is now higher than the interest rate banks pay on deposits, currently set at 3.06% for one year. That gives Chinese consumers a big incentive to spend or invest that money rather than let it sit in the bank.

Further, and of great Long-Term bearing on US interest rates – is how this will diminish demand for US Treasuries. When demand for any commodity decreases, the price also declines. When bond prices deteriorate as they have, rates go up.

4) In February this blog wrote:

“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. Corn is a staple of many food products that we eat. Increases in corn prices will not just impact corn flakes, but pop/soda, beef, and pig, chicken, candy bars, just about anything we eat.”

Grain stockpiles in many countries have fallen to multiyear lows, even as increased production of biofuels such as ethanol has added a new source of demand.

Even the best estimates of corn based fuel say that it will never replace the need for fossil fuels. At best it can only reduce the demand some. It would be much better for us to reduce our demand on foreign oil and decrease the price at the pump by; 1.) Drilling where we know that there is oil, 2.) Build refineries, 3.) Eat food as food.

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