Friday, June 12, 2009

What Come Up, Must Come Down

Given the craziness in the fixed income markets I thought an updated commentary which focused just that market is warranted. I'll keep this brief and simple.

In part, the massive run-up in mortgage rates was set-in-motion last month by whispers in the credit markets suggesting the United States might be on the verge of losing its prized AAA credit rating.

On Wednesday, Russia and Brazil put the world on notice that they each will begin investing in International Monetary Fund securities rather than the debt instruments of Uncle Sam. No sooner than these announcements hit the news wires - the yield on Treasury debt obligations and mortgage-backed securities skyrocketed as weaker, less experienced credit market participants bailed out of dollar-denominated assets.

Noteworthy, but this is more about political justling than anything else.

In Mortgages, 10-year notes and the Fannie Mae 5.0% 30-year fixed rate mortgage-backed securities are putting the finishing touches on a 200 basis-point two-day rally. A rally initiated by the fact that indirect bidders, which include foreign central banks, took home 49% of yesterday's $11 billion 30-year Treasury bond offering - marking the largest foreign investor participation rate at a U.S. debt auction since the Treasury Department reintroduced the 30-year bond in 2006. 49% indirect participation rate is a particularly telling statistic - coming as it does within hours of Russia's announcement that they intend to take their rubles and go play in credit markets elsewhere.

It takes two to tango. In response to Russia and Brazil, I am fairly confident a request was made to the Japanese (and other) to make some "line in the sand" comments. So, this morning the Japanese Finance Minister said his country's confidence in U.S. government debt is "unshakeable." His comments provided a nice little start to the trading day - as global investors responded to the solid endorsement from the second largest financer of American debt (behind the Chinese). In the coming week there will be no supply issues to deal with and the Fed will be active with a couple of small planned buybacks -- which leaves credit market participants with an opportunity to consider other influences effecting the trend trajectory of interest rates.

Next week's battery of macro-economic data ranging from the measures of inflation at the factory gates (Tuesday's May Producer Price Index) as well as prices paid at the front-door of every American (Wednesday's May Consumer Price Index) -- will likely be overshadowed by trading action in the stock markets. If, Corporate America falls short of generating the net income current stock valuations as I believe - stock values will fall and capital will flow back into the relative safe haven of Treasury obligations and mortgage-backed securities. That's a scenario that will be supportive of steady to fractionally higher fixed income prices. If I'm wrong, and the stock markets continue to soar - stock market gains will likely come at the expense of incrementally worsing mortgage interest rates. Those of you floating a fairly significant mortgage production pipeline may consider cashing in those loans (back to zero) as possible.