LOCKING BIAS

LOCKING BIAS

Of all economic reports, there are two that are primary drivers of the direction of mortgage interest rates – GDP (Gross Domestic Product) and PCE (Personal Consumption Expenditures).  It so happens that today we received a reading on both of them.  To begin with, GDP for the 3rd quarter of 2014 came in at a whopping 5%.  This is the highest reading in 11 years.  It was surprisingly higher than the 4.3% expected and much better than the preliminary reading of 3.9%.  This very healthy economic indicator caused the stock market to once again break above all-time high levels, pushing the DOW Jones Industrial Average above 18,000 for the first time in history.  Of course, this created a tremendous headwind for the bond market, adding upward pressure to mortgage interest rates.

PCE showed very tepid signs of inflation, with the Headline number coming in at -0.2%.  When you strip out food and energy, the Core rate was 0.0%.  On a year over year basis, Headline PCE dropped from 1.4% down to 1.2%, while the Core rate decreased from 1.6% down to 1.4%.   This is well below the Fed’s target rate of 2%, and is the last remaining argument the Fed has to maintain a Fed Funds interest rate near 0%.  Given the strength of the job market and the overall economy, interest rates should be much higher than they are today.  However, with inflation running at such anemic levels, there is risk of deflation if the economy were to slow.  Therefore, the Fed is maintaining low interest rates as long as they can until signs of inflation appear.

Also worthy of mention is the reading on Consumer Sentiment for December.  It came in at 93.6, which was higher than the 93 expected and the highest reading in nearly 8 years.  As consumers feel more confident about the economy, they tend to spend more which increases GDP and stimulates additional job growth.  The fear many have is that by the time inflation appears, economic conditions will be too strong to slow to avoid rapid inflation.

The scenario we talked about yesterday seems to be playing out, with stocks shooting to all-time highs and mortgage bonds falling sharply.  We are most certainly going to maintain our locking bias, as the risk of floating is just too high.  Both mortgage bonds and the 10 Year Treasury Note are testing support.  Like a wright on a string, the support is showing signs of fatigue.  If support breaks, the fall could be sharp and would push mortgage interest rates higher.