Bonds trading in sideways pattern

The markets opened Christmas week quietly, with both stocks and bonds trading near even.  With tomorrow being a much heavier news day, the calm today could be temporary.  In fact, tomorrow we will get a report on PCE (Personal Consumption Expenditures).  This is the Fed’s favorite gauge of inflation, and certainly can be a market mover.  If inflation proves to continue to be on a downward path, mortgage rates will respond kindly.  However, any upward surprise will be especially negative as the markets are now expectant of lower levels of inflation.  It is the low inflation expectations that are a primary culprit for the Fed to maintain its argument for continued low interest rates.  Once inflation moves higher, the Fed will likely respond with quick and aggressive rate hikes to counter what many believe will be a market of rapid inflation.

The stock markets were able to once again test all-time highs on Friday, as the recovery in the stock market continued its path higher.  In October, we saw significant stock market losses followed immediately by new all-time highs.  Then again in December we saw a dramatic drop in the stock market, which was immediately followed by the best two days in the stock market since 2011.  Will this path continue and set new records highs?  At this point it appears likely.  Especially considering that Christmas week is typically a favorable week in the stock market and not as favorable to the bond market.  We will have to wait and see.  However, a continued climb higher in stocks will add upward pressure to mortgage interest rates and could set to path a strong start for the equity market in 2015.

After making an impressive run higher, mortgage bonds are now trading in a sideways pattern.  Bonds will eventually be squeezed out of the range and will be forced to make a move either higher or lower.  At this point, the direction is not yet determined.  However, history tells us that when a sideways channel is broken it is typically a strong move that follows.  Given the risks associated with a downward break, and continued strength in the stock market, we are going to maintain our locking bias.  Again, we must be carefully watching the 10 Year Treasury Note.  If the yield on the 10 YTN breaks above 2.22%, we will likely be on a path of higher interest rates.  If we can muster through the week and remain beneath the critical 2.22% level, mortgage rates could potentially build strength to make another run higher.