Market Analysis

Below is Larry Baer with Market Alert's commentary for today:

Larry Baer:  Yesterday's relatively weak demand for a record $30 billion offering of five-year Treasury notes has heightened anxiety Uncle Sam will struggle to raise the $2 trillion he plans to spend this year on a mixed-bag of economic stimulus programs. These worries propelled government benchmark yields to their highest levels in nearly two months. As long as major questions exist with respect to the willingness of foreign investors to finance our burgeoning federal deficit -- the prospects for notably lower mortgage interest rates will be very limited.

The Commerce Department reported this morning the economy shrank at its fastest pace in more than 25 years during the final three months of 2008. Gross Domestic Product, a statistical measure of total goods and service output within U.S. borders, plummeted at a 3.8% pace during last year's fourth-quarter. It was the sharpest quarterly decline since the first-quarter of 1982 when GDP contracted by 6.4%.

In the convoluted world of the credit markets, weak economic news such as this morning's Q4 Gross Domestic Product numbers would generally spark a rally in the mortgage market to higher prices and fractionally lower rates. Many find it surprising, given the magnitude of the economic swoon, that mortgage interest rates have failed to improve much, if at all.

I think there are two core reasons the mortgage market has not reacted as many had anticipated. 1.) Investors have already priced into the mortgage market their forward looking expectations for horrendous economic news. Under these conditions the actual data looses much of its relevance and by extension - its "power" to create a reaction among market participants. 2.) The fear that yields on longer-dated Treasury obligations will rise sharply as the government is forced to aggressively "sweeten-the-pot" to entice global investors to cover the cost of the largest federal deficit in American history will have a chilling effect on any effort by mortgage interest rates to move lower. When our own central bankers are hesitant to become a direct buyer of longer-dated Treasury debt -- it is highly unlikely foreign investors will be overly enthused about buying heavily in that asset class either. Rising yields on government debt tends to lift all the boats in the harbor - including mortgage interest rates.

Looking ahead to next week -- Monday's release of the Fed's favorite measure of inflation at the consumer level, the personal consumption expenditure index (a component of the broader December personal income and spending report) and the January Institute of Supply Management's measure of manufacturing activity will likely draw little attention from mortgage investors.

For the majority of the week the trend trajectory of mortgage interest rate will likely be most influenced by news reports surrounding the progress of a $900 billion package of tax cuts and spending programs that will be making its way through the Senate. Hopefully, some of the pork will be trimmed from the legislation -- like a program that would authorize the expenditure of $400 million to prevent sexually transmitted diseases. I don't think anybody doubts the importance of preventing sexually transmitted diseases - but most market participants believe job creation and economic recovery probably needs to take immediate precedence - especially if a massive amount of debt is going to be incurred to make it happen.

The credit markets will also likely get bounced around a bit as Treasury Secretary Geither announces a much anticipated rescue plan for the banks next week. The plan may center on a "bad bank" that would purchase distressed debt instruments from banks and dump them into a taxpayer-backed portfolio that might someday turn a profit. This approach would theoretically clean up bank balance sheets while giving the credit markets a fresh start to help propel the economy of its current recessionary mire. If market participants like the proposal - they will likely be willing to nudge mortgage interest rates lower. On the other hand, should the proposal is deemed to be unworkable; investors will likely express their disappointment by pushing mortgage rates fractionally higher. In my judgment this event will be the "wild card" of the week.

On Friday at 8:30 a.m. ET the Labor Department will release the January nonfarm payroll figures. Market participants have already priced in expectations for another 525,000 swoon in the headline payroll figure -- as well as a jobless rate of 7.5%. The actual numbers will probably fall within shouting distance of the consensus estimate - rendering this report essentially toothless with respect to its impact on the trend trajectory of mortgage interest rates.