Market Analysis

For a day following a major Fed rate cut not much really changed in the rate picture.  The mortgage market improved in the morning, lost steam mid day and then finished the day improved from yesterday (bond prices higher and yields lower).  Today both the stock market and bond market for US Treasury's and mortgages backed by Fannie Mae and Freddie Mac ended up.  What happened?  At the beginning of the day there was an large "flight to quality" with funds flowing into the bond market as the market worried about losses at the large bond insurer MBIA and a Standard & Poor's forecast that mortgage securities losses could total more than $265 billion.  By the end of the day though the CEO of MBIA held a news conference that somewhat soothed investors worries.  The reason that the stock market is so concerned about the major bond insurers is that bond insurance is what allows corporations and municipalities to lower their borrowing costs (and, in the case of corporations, increase their profits).  More specifically, there are many institutional investors such as mutual funds or insurance companies whose charters only allow them to invest in bonds with a strong rating.  Once these bonds are downgraded these investors would need to liquidate their portfolios, essentially creating havoc not just in the market for corporate and municipal finance but also creating an additional liquidity crises for a wide array of debt offerings ranging from pools of auto loans, consumer durable loans, credit card pools etc..  With the economy already reeling from the problems in the real estate market there is great fear that if these problems create a crisis in the market for other debt instruments that we could truly have a calamity on our hands.  All of this in backdrop of an upcoming election cycle.  So, what to make of all this?  Are rates going lower or higher?  If you are looking to the market to predict which way things are going to go it is interesting to note that the shares of stocks you would think would be some of the most troublesome have been rallying (homebuilders and banks).  If the bottom has truly formed in the stock market and  investors decide that now is the time to get on the train for returns they expect later in 2008 or into 2009, then all the bad news we hear now won't really matter much as the flow of money from bonds to stocks will cause long term rates to rise.  Additionally it is hard to conceptualize there not being some form of "bailout" if the major bond insurers do truly hit the wall which would be very stock market friendly.  Finally, it is important to remember that the stock market is still pricing in future easing by the Fed, which is expected to further stimulate the economy.  If the stock market doesn't take a nose dive on news from S&P that mortgage losses could total $265 billion, maybe investors are becoming numb to the bad news?  Where the rubber will meet the road is in 5 major areas:  corporate profit reporting and corporate guidance to analysts about future performance, the strength or weakness of employment figures, inflation measures, the strength or weakness of other global economies as it relates to global demand for US goods and services which are now on a firesale given that the value of the dollar is so weak, and, the wild card, which is a disruptive geopolitical event like a terrorist attack (which could really send the stock market into a tailspin with those funds going into bonds thereby moving bond prices up and yields/rates lower).  In the background though, you have a Fed that is cutting rates, a Congress that is highly motivated to get a stimulus package out and is already contriving other "bail out" type packages, and a relatively resilient consumer, who, as long as they don't lose their job, keeps spending everything they make.  With all these cross currents it is really probably better to lock when you know you are within 30 to 45 days of closing and then use our one-time renegotiation tool if rates do move lower. 
Posted by Matthew Breston on January 31st, 2008 5:36 PMPost a Comment (0)
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