Today at 12:00 pm MST, we expect the Federal Reserve to announce the first interest rate hike in the new cycle. Since we have not been in an increasing rate environment since June of 2006, there is a great deal of anxiety and anticipation in the market. As a result, mortgage bonds have fluctuated wildly and now sit on a critical level of support. In addition, the 10 Year Treasury Note yield now sits just below overhead resistance. Both barriers in the two markets could quickly fail given the current instability and volatility. However, the reality is that the market is fully aware of this and should have most of the change already priced into the market. Much of the reaction will depend upon the comments from Fed President Janet Yellen that will follow the initial announcement. We believe she will be gentle in her approach and assure the market that the rate of increase will be gradual and continue to be data dependent. That should help minimize the knee-jerk reaction that we often see with major change.
Also playing out in the market is a significant occurrence in the beginning of a collapse of the Junk bond market. As a result of oil prices hitting the $35 per barrel range, Shale Oil Drillers in the US are beginning to default on their high yield junk bonds. When you consider that their cost per barrel is $70 to produce and they are only able to sell for $35, this industry is losing a significant amount of money each day. To stay alive, they used forward hedging to lock in the old, higher prices. Those hedges are now expiring and they are forced to sell at today’s current market rates. The massive rate of default within the junk bond market is spilling over into more conservative fixed income investments, such as mortgage bonds and the 10 Year Treasury Note. This adds to the upward pressure to interest rates already created within the bond market due to the actions of the Federal Reserve.
There is a possibility that we will see a bond market rally following the rate hike. However, for today and several days ahead, we are likely to see continued deterioration as the market reacts to the news. For loans needing to close soon, we will maintain our locking bias.