Market Analysis

In what has been a continued pattern this week, news-grabbing headlines are serving to trump the underlying better-than-expected economic news and support the "flight-to-safety" trade which has kept 30 yr mortgage rates below 5%.  This morning the big news is Standard & Poor's downgrade of Goldman Sachs stock to "Sell" due to news that federal prosecutors are looking into whether to charge the bank with criminal charges related to the way they bundled and sold mortgage-backed securities while at the same time "betting" against them.  This news is driving stocks, which had opened higher, slightly lower now.

In economic news, the Advance Estimate for 1st Qtr 2010 GDP came in projecting 3.2% growth, which was slightly lower than the 3.3% projected growth but which makes for 2 positive quarters of GDP growth.  The Chicago Purchasing Manager's Index came in at 63.8 vs expectations of a 59.9 reading.  The final April University of Michigan Consumer Sentiment index came in at 72.2 which was better than the 71.0 the market was expecting.

Stocks have regained their footing, with the Dow currently up 125 points.  Bonds are flat after a down day yesterday.  Yesterday afternoon the Fed released their post meeting statement indicating that economic activity was improving but that high unemployment and lack of inflation pressures would most likely justify keeping short term rates at very low levels for the forseeable future.  It is important to note that the Fed does not directly control mortgage rates which are market driven and which correlate with the auction prices of longer term US Treasury notes, particularly the 10 Yr Treasury note.  Investor appetite for US Treasuries is a function of supply and demand and of investor perceptions of future inflation and currency movements (if a foreign investor purchases a long term debt at a set interest rate that is not inflation indexed, they are very concerned with their post-inflation and post currency exchange return).  We have been fortunate that the European debt crisis occurred just as the Fed stopped purchasing mortgages, as this has driven money into US Treasuries and Fannie Mae and Freddie Mac mortgage-backed securities (MBS) as a safe-haven move.

In economic news today, Initial Jobless Claims for the week ended 4/24/10 were down to 448,000, a reduction of 11,000 from the week prior.  This was just slightly worse than market expectations for a reduction of 14,000.  Continuing Jobless Claims for the week ended 4/17/10 were down to 4.645 million vs expectations for a drop to 4.25 million from a revised 4.663 million the week prior (the prior week's Continuing Claims had been revised up to 4.663 million from 4.646 million).  The slightly weaker than expected employment data and the continuing European debt saga has helped keep bonds from performing worse today even as the stock market rallies.

Both bonds and stocks opened up slightly better this morning with the Dow over the 11,200 mark and the US 10 Yr Treasury just below the 3.8% mark at a yield of 3.78%. Treasury bills are stronger on expectations that this week’s $115 Billion of Treasury notes will be well bid by foreign central banks moving funds into US treasuries while they watch what unfolds with the Greek financial crisis. Stocks continue to be buoyed by the strength of quarterly earnings and the perception that, while improvement in the employment sector is lagging, the recession is most likely over. Expectations for the advance estimate of 1^st Qtr 2010 GDP growth are for 3.2% growth compared to 5.6% growth in 4^th Qtr 2009.

The economic calendar for this week is recapped below:

Monday, April 26, 2010

• US Treasury auctions $11 billion of 5-year inflation indexed notes.

Tuesday, April 27, 2010

• February Case-Shiller 20 City Index – the market expects the monthly decrease in home prices to be .1% compared to a .7% decrease in January and, on a year-over-year basis the market expects a 1.1% increase in home prices for this index.
• April Consumer Confidence – expectations are for a reading of 53.7 vs a 52.5 reading in March
• First day of a two-day Federal Open Market Committee (FOMC) meeting
• US Treasury auctions $44 billion of 2-year notes

Wednesday, April 28, 2010

• US Treasury auctions $42 billion of 5-year notes
• FOMC Meeting Conclusion, Rate Decision and Post Meeting Statement – the market expects no change in either the Federal Funds Rate or the Discount Rate and for the Federal Reserve to remain cautious about economic recovery due to unemployment hovering near 10% with no clear signal that it will improve significantly this year.

Thursday, April 29, 2010

• Initial Jobless Claims for the week ended 4/24/2010 – expected to drop by 16,000 to 440,000.
• Continuing Jobless Claims for the week ended 4/17/2010 – expected to drop by 21,000 to 4.625 million.
• US Treasury auctions $32 billion of 7-year notes

Friday, April 30, 2010

• Advance Estimate for Qtr 1 2010 GDP – expected 3.2% growth compared to 5.6% growth for the 4^th Qtr 2009.
• April Final University of Michigan Consumer Sentiment Index – expected 71.5 reading vs initial reading of 69.5 earlier this month.
• April Chicago Purchasing Manager’s Index (PMI) – expected up to 59.8 vs 58.8 in March

Mortgage-backed securities (MBS) deteriorated further during the day yesterday.  This morning they have  continued their negative bias as initial quarterly earnings from large Dow components such as IBM , Coca-Cola and Johnson & Johnson have come in stronger than expected.

Below is a recap of this week's economic calendar which we did not post in yesterday's entry:

Monday, April 19, 2010

• March Leading Indicators - up 1.4% vs expectations for a 1.1% increase. February was also revised up from a .1% increase to a .4% increase.

Tuesday, April 20, 2010

• No Key Economic Reports

Wednesday, April 21, 2010

• No Key Economic Reports

Thursday, April 22, 2010

• Initial Jobless Claims week Ended 4/17/10 - expected down 29,000 from 484,000 to 455,000.
• Continuing Jobless Claims week Ended 4/10/10 - expected down 39,000 from 4.639 million to 4.60 million.
• March Producer Price Index - expected up .5% vs Feb down .6%.  The Core PPI (excluding food and energy) expected up .1% vs up .1% in Feb.
• March Existing Home Sales - expected up 28,000 to an annualized pace of 5.3 million vs a pace of 5.02 million in February.

Friday, April 23, 2010

• March Durable Goods Orders - expected up .2% vs up .9% in Feb.  Excluding Autos expected up .6% vs up 1.4% in Feb.
• March New Home Sales - expected up 17,000 from an annualized pace of 308,000 to a pace of 325,000.

Bond markets opened up this morning on stock market weakness.  The SEC  charged Goldman Sachs with fraud over how it marketed investments in subprime mortgages.  This news sent financials downward despite better than expected earnings reports from GE and Bank of America.

Bonds improved further in mid morning trading as selling pressure for equities increased.  However, mortgage-backed securites have lost some of their mid morning gains. 

In economic news, March Housing starts came in at a 1.6% increase vs expectations for a 5.7% increase.  However due to February's starts being revised from -5.9% to a gain of 1.1% the March annualized Housing Start pace of 626,000 beat the market's expectation of a 610,000 annualized pace.  March Building Permits were up to a 685,000 annualized pace vs expectations for 625,000. 

Equity investors seem to be paying more attention to a weaker than expected University of Michigan Initial April Consumer Sentiment index which came in at 69.5 vs expectations for a 75.0 reading and down from a reading of 73.6 in March. 

Below is today's market analysis from David Shirmeyer with Sigma Research:

The bond market tried to rally yesterday morning past a technical resistence point at 3.8% and failed.  Bonds lost steam during the day and are relatively flat with a slight negative bias this morning. 

In economic news, March's Consumer Price Index (CPI) was up .1% vs expectations of no change, but the core rate, excluding food and energy was unchanged, vs expectations for a .1% increase.  March's Retail Sales were up 1.6% vs expectations for a 1.2% increase and, excluding the Auto segment, were up .6% vs expectations for a .5% increase.

Bonds improved yesterday afternoon and the momentum is continuing today.  Some investors in equities are nervous about the run up in stocks which took the Dow over the 11,000 level yesterday for the first time in 18 months. They are moving money into US Treasuries and Fannie Mae and Freddie Mac Mortgage-Backed Securities (MBS) in a defensive move.

In economic news, the February US Trade Gap increased to $39.7 Billion vs expectations for a $39.0 Billion gap.  The increase in the gap was caused by mostly by non-petroleum items goods.

Bond markets are fairly flat with a slight positive bias in early morning trading. This week starts light in terms of economic data and then picks up beginning on Wednesday.

Below is a recap of the releases from this week’s economic calendar:

Monday, April 12, 2010

• No key data releases

Tuesday, April 13, 2010

• February Trade Balance – expectations are for a $39.0 Billion trade gap for February, up from $37.3 Billion in January

Wednesday, April 14, 2010

• March Consumer Price Index (CPI) – the market expects the CPI to be up .1% vs 0% in February. The Core Rate, excluding food and energy, is expected to also be up .1% vs a .1% increase in February.
• March Retail Sales – the market expects an increase of 1.1% vs a .3% increase in February. Excluding the auto component, the market expects a .5% increase vs a .8% increase in February.
• February Business Inventories – the market expects a .3% increase vs 0% in January.
• April Federal Reserve Beige Book - The compilation of economic reports from all 12 Federal Reserve districts is expected to show economic activity picking up but continue to show a challenging employment picture.

Thursday, April 15, 2010

• Initial Jobless Claims for the Week Ended 4/10/10 – expected down 20,000
• Continuing Jobless Claims for the Week Ended 4/3/10 – expected up 50,000
• March Industrial Production and Capacity Utilization – Production expected up .7% vs a .1% increase in February. Capacity utilization expected at 73.3% vs 72.7% in February.
• April Philadelphia Fed – this regional business conditions index is expected to improve to a reading of 20.0 from 18.9 in March.

Friday, April 16, 2010

• March Building Permits and Housing Starts – building permits expected to decrease to an annualized past of 626,000 units from 637,000 units in February. Building starts expected to increase to an annualized pace of 610,000 from 575,000 units in February
• April University of Michigan Consumer Sentiment Survey (initial estimate) - expected reading of 75.0 vs 73.6 in March.

Bond markets are flat this morning after improving yesterday on comments by Fed Chair Bernanke that indicated that the economy is still on shaky ground due to the employment situation.  Addditionally, the 10 Year US Treasury note auction yesterday was the best bid in the history of tracking bid/cover ratios with a 3.72 bid/cover ($3.72 in bids for every $1 auctioned).  The yield on the 10 year note came in lower than anticpated at 3.9%, however, that yield is still significantly higher than the 3.7% range in which the 10 year note had been trading prior to the last run up which began on March 24.

In this morning's economic news, Initial Jobless Claims for the week ended 4/3/10 were up by 18,000.  The market had expected a 7,000 decrease.  Continuing Claims for the week ended 3/27/10 were down by 131,000.  The market had been expecting them to be down only by 51,000.

The bond market opened slightly positive and is now gaining a bit of steam.  It is possible we could see an updated rate sheet from Wells Fargo mid day if the improvement holds.

Yesterday's minutes from the Fed's last Open Market Committee meeting did not produce any surprise hints of rate increases. Also, yesterday's US Treasury auction was well bid and today's 10 Year Note auction was also well bid.

Today's only economic data release is Consumer Credit at 2 pm CST. 

Bonds are under pressure again as March’s Institute of Supply Management (ISM) Service Sector Index came in stronger than expected with a reading of 55.4 vs expectations of a 54.0 reading and 53.0 reading in February. Also, February’s Pending Home Sales were up 8.2% vs market expectations for no change. It is likely we will see a mid day price change for the worse.

To recap what occurred last week, the Fed stopped purchasing mortgage-backed securities (MBS), March’s Non Farm Payroll report showed private sector employment at a much stronger level than was expecting. Of the 162,000 higher non-farm employees on payrolls in the March report, only 48,000 were from the Federal Government which is hiring temporary Census workers. Analysts had expected government employment growth to make up a larger component of the increase.

This week’s economic calendar is very light but it is a heavy week for US Treasury auctions. Below is a summary of the key events:

Monday, April 5, 2010

• March ISM Services Sector Index – came in at 55.4 vs expectations of 54.0
• February Pending Home Sales – up 8.2% vs expectations of no change.
• US Treasury Auction - $8 billion of 10-year inflation indexed notes

Tuesday, April 6, 2010

• Minutes of Last Federal Reserve Open Market Committee Meeting
• US Treasury Auction - $40 billion of 3-year notes

Wednesday, April 7, 2010

• February Consumer Credit Balance – expected up $1.6 billion
• US Treasury Auction - $21 billion of 10-year notes

Thursday, April 8, 2010

• Initial Jobless Claims Week Ended 4/3/10 – expected down 6,000
• US Treasury Auction - $13 billion of 30-year bonds

Friday, April 9, 2010

• February Wholesale Inventories – expected up .3%

The bond market opened down sharply this morning.  Below is commentary from David Shirmeyer with Sigma Research:

Not a good open this morning; the rate markets opened soft on better outlook for the stock market today. At 9:00 the 10 yr note -6/32 3.85% +2 BP, mortgage prices are continuing to fall, at 9:00 -10/32 (.31 bp) frm yesterday's close; the DJIA traded +67 in the futures markets. At 9:30 the DJIA opened +76, 10 yr note -8/32 to 3.86% +3 BP and mortgage prices -10/32 (.31 bp).

Weekly jobless claims were in line with estimates this morning; down 6K to 439K new unemployment filings. Continuing claims were fractionally lower at 4.662 mil frm 4.668 mil last week. The 4 wk average of unemployment claims is now at its lowest since 9/13/08 and continuing claims at their lowest since 12/08. Claims have been slowly declining over the past couple of months confirming employers are ending their job cuts, however claims are still high historically and the unemployment rate remains at 17% to 20% when discouraged workers are counted. The BLS reports them in the guts of the data but as we know, its the "official" unemployment rate that hangs at 9.7%.

At 10:00 two additional data points; Feb construction spending expected -1.0% was down 1.3% the lowest level of spending since Nov 2002; Jan construction spending revised fro -0.6% to -1.4%. The decline in spending was expected and is being over-shadowed by the March ISM manufacturing index that increased more than expected at 59.6 compared to forecasts of 57.0. The new orders component increased to 61.5 frm 59.5, prices increased to 75 from 67 and employment slipped fractionally to 55.1 frm 56.1. Any of the index readings over 50 indicates expansion. The initial reaction sent eh 10 yr note price lower and mortgage prices 4/32 (.12 bp) lower than at 9:30 this morning.

US stock markets are strong into the open, being fueled by strong economic reports from China and Japan this morning. Asian stocks and commodity prices climbed after China’s Purchasing Managers’ Index rose to a seasonally adjusted 55.1 last month from 52 in February, according to Li & Fung Group, a Hong Kong-based company that releases data for the Federation of Logistics and Purchasing. In Japan, the Tankan index of sentiment among the country’s largest manufacturers rose to minus 14 in March from minus 25 in December, the least pessimistic since 2008, according to the Bank of Japan.

Inch by inch the economic outlook is continuing to improve and drawing money into stocks and away from the bond markets. It is getting more difficult to hold to the potential of an economic double dip; that view or outlook based on the continuing weak housing sector, high unemployment with little expectations of strong job growth and declining consumer spending. Consumer spending has picked up recently; it may be necessary spending and more discretionary spending, whatever spending has picked up the last three months.

Here comes more supply; this morning Treasury will announce next week's auctions; likely a total of about $80B. Now that the Fed is out of the game in purchasing US treasuries and mortgages the pressure on rates is increasing. So far this week the MBS markets have been weaker than the weakness in treasuries; not much but most likely due to the Fed's ending of MBS buying. We however remain with our view that MBS markets will not experience inordinate increases in rates in relationship to treasuries. So far that is the overall consensus based on our canvassing of dealers and large investors. We will focus on it over the next few weeks, this week's action is somewhat bothersome but too early to make any definitive assessments. On the larger outlook all interest rates are likely to head higher as long as economic growth is anticipated.

Beside the improving economic outlook that has pushed rates higher recently; crude oil increases are reviving inflation concerns. Crude today is pushing $85.00.