There was nothing for traders to look at in terms of economic data today.  There were reports that there will be a rate cut in the future by the FED.  But those rumors diminished by this afternoon, causing rates to close higher. 

The 10-year Treasury closed at +.030% to 4.620%.

The MBA Purchase Application Index is ignored by bond investors.  But, it can give us clues to the future of the real estate sector. It was a little bit lower than last week’s 464.9, but the four week moving average improved this week.  The weekly number was 441.5.  The 4 week average was 442.6.

MID-TERM OUTLOOK [23 August 2007]

There are some bright spots, and a couple dark spots for rates in the next few months.  First, the good news for rates.  But, remember, good news for rates often means bad news for the economy. 

A.)  Investor Sentiment seems to have turned.  During most of the 2^nd quarter investors seemed to grab onto any news that would increase rates.  At the same time, they ignored news that would have lead to lower rates. 

On 18 July, FED Chair Ben Bernanke stated he saw evidence that inflation would be lowering in the last ½ of 2007.  (He was optimistic for 2008.  See Long-term outlook.)

        Sentiment on the part of bond investors clearly changed as of 18 July 2007.  On that day the 10-year Treasury traded below the recent floor of 5.000%.  On the next day, and on 20 July, and Monday 23 July the 10-year Treasury closed below that 5.000%.  What is significant about those two days is the complete absence of significant data.

B.   Inflation has been encouraging.  CPI, PPI and PCE all have been at or bellow expectation.  Inflation is the greatest fear for bond investors.  Better than forecast inflation numbers have brought investors back in.

C.   Consumer Sales numbers have improved over the 2^nd quarter, but not in such a dramatic way to threaten inflation.

D.   The housing bubble has burst.  But, will housing continue to decline?  Is it flattening?  Or, is it on the verge of a rebound?  The data over last year has been mostly negative, but there can always be evidence indicating other directions. 

The housing market problems have a way of creating a cycle.

Clearly, the sub-prime mortgage industry was lending money to buyers that could not repay.  That has resulted in very high default and foreclosure rates.  These problems in the subprime market cause investors to steer money away from the sub-prime lenders.  At the same time, there was a lot of housing activity in the years up to 2004.  Eventually this high amount of activity came to an end.  (All economic events are cyclical and they usually work out this way.)  But, when the boom ends prices and activity fall off.  That is the condition we are in the middle of 2007. 

Now, we have the perfect storm.  While not the majority, many of the home buyers were those that qualified for the sub-prime mortgages.  Now with fewer buyers, the housing market is hurting more.  That is causing prices to go lower.   That means more foreclosures when problems occur.  That means more skitterish nervousness from investors in mortgage instruments.  And thus, the cycle continues.

Steve Boxmeyer [612] 799 – 6858

steve@LendWithIntegrity.com