Bonds Gain Strength, Then Lose It

Investors entered the market with a show of strength this morning, driving stocks to set net all-time high records while also pushing bond prices higher. The strong opening was primarily driven by reports of lower inflation via the Consumer Price Index (CPI). It was reported that although inflation for the month of June was unchanged, the year over year Headline number dropped from 1.9% down to 1.6%. Considering that this was at 2.7% just a short time ago, the direction of inflation is clearly on a downward path. This has been the Fed’s fear as they drove interest rates higher, and may cause reason for the Fed to hold off in the near-term on making additional increases to the Fed Funds Rate.

Yesterday, Fed President Janet Yellen made a disturbing comment regarding the reduction of the Fed’s balance sheet. She said that although they plan to maintain a higher amount of investments than before the markets crashed in 2008, they only intend to hold 10 Year Treasury Notes. This means that all the mortgage backed securities they now hold are planned to eventually either fall off their balance sheet as loans are paid back through homes selling or being refinanced, or they will eventually be sold off in the open market. This translates to higher mortgage interest rates in the future. However, it could take years for the full impact to be felt. In the meantime, we will continue to enjoy the low rate environment while it lasts.

Mortgage bonds are now trading in a wide channel. With prices well off their highs of the day, we will maintain our locking bias.