Market Analysis

The bond market worsened today on better than expected March Retail Sales.  This week's keys reports are the March Producer Price Index released tomorrow morning (Tues) and the Consumer Price Index released on Wednesday morning. Both of these measures of inflation will be watched carefully as investors try to gauge the probabilities of an additional Fed Rate cuts.  It is important to note that additional short term Fed rate cutting, should it occur, may not cause long term rates to improve markedly and could cause a worsening of long term rates.  The short term rates cuts are designed to stimulate the economy which causes investors to build in a higher likelihood for inflation and rate hikes in the future.  Investors purchasing long term bonds and mortgage-backed securities are more focused on the medium and long term prospects for rates than they are in the very short term.  Investor's expectations of higher longer term rates is what causes the yield curve to steepen.  This is a phenomenon where rates move distinctly higher as maturities of bonds get longer.  Short term Fed rate cuts cause an already weak dollar to become weaker which makes long term bonds and mortgage-backed securities less attractive to foreign investors who have to translate the yields they are paid on bonds into their own, stronger currencies.  Fed rate cutting also reinforces the belief that the building blocks are being put in place for a stock market recovery, particularly in the financial sector where banks make larger profits when the "spread" between their cost of money and the rates they charge borrowers for credit cards, car loans, home equity loans,  commercial loans etc., increases.  I did not list home loans in that group because most home loans are not held on bank's books but instead sold to Fannie Mae and Freddie Mac who then pay the banks to service those loans.  The volume of mortgage loans in dollars is far too large for banks to continue to make them without replenishing their funds via selling the loans to Fannie and Freddie.  It is important at times like these to watch the market carefully.  If things seem to slip and rates start moving upward, it is very easy to get stuck on the sidelines waiting for a return to your "target" while the market moves notably higher.   This is all the more perplexing when it comes in the midst of headlines of possible additional Fed rate cuts
Posted by Matthew Breston on April 15th, 2008 12:23 PMPost a Comment (0)
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