All in all it was a good day for interest rates. Only one item may have spooked the bond market; aggregate CPI. Total CPI was forecast to be +0.1% but was reported at +0.2%.

Core CPI was at the predicted +0.2%.

Housing Starts were predicted to be 1450k to 1460k but were higher at 1467k. That should have caused rates to skyrocket as it shows strength in the economies weakest sector. It may have been tempered some by building permits, which were a low 1406k. Building Permits are not as valuable as starts.

The market thankfully ignored the numbers and concentrated instead on sub-prime mortgage concerns and the testimony of FED Chair Ben Bernanke.

Prior to Mr. Bernanke’s speech the 10-year Treasury was -.016 with the rate at 5.062%.

"Overall, the U.S. economy appears likely to expand at a moderate pace over the second half of 2007, with growth then strengthening a bit in 2008 to a rate close to the economy's underlying trend," Mr. Bernanke said

Economic growth should pick up despite the continued housing drag, Mr. Bernanke added in testimony before Congress, and against that backdrop inflation has remained the "predominant" policy risk, he said, suggesting that the likeliest scenario remains a lengthy continuation of the Fed's year-long pause in interest rates.

But Mr. Bernanke warned that possible declines in the economy's underlying rate of productivity may keep a lid on growth. Indeed, the Fed lowered its 2008 central tendency growth domestic product growth forecast to between 2.5% and 2.75% from its February forecast of between 2.75% and 3%. It also lowered its 2007 GDP forecast due to the weak housing sector.

Bernanke, in prepared testimony to the House Financial Services Committee, said that core inflation "should edge a bit lower, on net, over the remainder of this year and next year."

"If energy prices level off as currently anticipated, overall inflation should slow to a pace close to that of core inflation in coming quarters

Mr. Bernanke called the Fed's expectation for 2008 GDP growth "close to the economy's underlying trend," suggesting that the economy isn't as able to grow rapidly without inflation as it was in the past. The economy's non-inflationary potential was once thought to be above 3%.

The Sub-prime mortgage market is also causing concern to the bond traders. Two hedge funds that made big bets in the subprime mortgage market are worth virtually nothing, according to a letter the investment bank sent to clients. Fed Chairman Ben Bernanke told Congress that the situation would likely get worse before getting better

After that speech by the FED Chair, and the analysts announced continued concern about the sub-prime mortgage market, the 10-year touched and tested the trading bottom of 5.000%. The low for the day was at 4.991% which was -.087%.

There was some recovery and the 10-year Treasury closed +.068% at 5.010%.

There was an item that did not impact rates, but they did point towards this morning’s increase in Housing Starts. The MBA Purchase Application Index held steady at 446.5 in its weekly number. The 4-week moving average is at 441.65.

SHORT-TERM OUTLOOK [16 July 2007]

Thursday starts out quiet at the morning opening with the weekly Initial Jobless Claims, the Leading Economic Indicators, and Philadelphia Fed Index.

The activity may pick up in mid-morning as FED Chair Ben Bernanke continues his testimony in Washington D.C.

The activity in the afternoon will most likely pick up with the release of the FOMC Minutes. The FOMC Minutes are read closely by bond and stock analysts to know exactly where the bond market is moving.

There is no significant data on Friday.

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